The Securities and Exchange Commission is reconsidering proposals to curb market timing and eliminate late trading because the measures may unfairly affect pension plan participants and other long-term shareholders, according to the Government Accountability Office.

The GAO, formerly named the General Accounting Office, said in a recent report to the House Ways and Means subcommittee on Oversight, that the new rules the SEC is proposing should be modified. In the report, which was prepared at the request of the committee, the GAO contends that in order to implement these new rules, fund companies and intermediaries will need to invest in new technologies and that cost will get passed down to shareholders. The agency also said the late-trading provisions will disrupt the way pensions process certain transactions.

Pension plan assets make up a significant amount of business for the fund industry. More than one-fifth, or 21% of the $10 trillion in pension plan assets, is invested in mutual funds.

The proposals in dispute are the "hard close" rule and the mandatory 2% redemption on short-term trades. The hard 4 p.m. close proposal is intended to eliminate late trading and will require, if adopted, that fund companies or intermediaries, including broker/dealers, banks, insurance companies and pension plan administrators, receive mutual fund buy or sell orders no later than 4 p.m. in order to receive that day's price.

To curtail market timing, which is not illegal per se, but harms long-term investors, the SEC is suggesting a mandatory minimum 2% redemption fee on all fund shares bought and then sold within five business days.

The proposed regulations would benefit investors in that they could help stop the abusive trading practices that led to the biggest scandal in the history of the industry, the GAO contends, but the moves could also hurt investors as well, and pension plan participants more than others. In addition to added technology costs, the proposed late-trading fixes will create processing complications during certain transactions for pensions, especially during loan transactions.

Participants in defined contribution plans sometimes borrow from their retirement savings, and the new rules could create headaches for those involved. Plan recordkeepers need to know the value of the participant's shares at the end of the day to ensure the amount requested is provided and to also make sure the request is in compliance with the pension plan's rules.

Under the new "hard close" rule, recordkeepers would be required to submit orders to withdraw shares even before those shares are valued. Therefore, participants could then receive incorrect loan amounts, possibly higher than the amount allowed by the plan, thus putting that individual in violation of the pension plan's rules.

Pension plan administrators anticipate the proposals will give investors who place orders less time, making them submit their orders by noon or 2 p.m. ET in order to give pension plan recordkeepers enough time to process the information before sending the orders along to the fund shop, transfer agent or NSCC.

While not making specific recommendations on alternatives for the SEC to include, the GAO did mention the "Smart 4" proposal. The rule would allow intermediaries the same flexibility they enjoyed in accepting trades up until 4 p.m. and then later processing and submitting them. The report also mentioned another alternative, the "Clearinghouse" proposal, which would require all fund orders to get an electronic time stamp at a central location to verify the time it was received. Orders stamped prior to 4 p.m. would receive that day's price.

The GAO also said that plan participants could inadvertently get caught up in the redemption fee trap aimed at taking down timers if the SEC's current proposal is adopted. The report indicated that individual participants could be forced to pay the 2% fee even when moving from one fund to another simply to meet an investment objective and not trying to manipulate the system. While the SEC has included some exceptions into the proposal, there are still areas where innocent investors could be forced to pay the unwarranted fee.

"We share the concerns that the GAO has identified in the draft report," wrote Paul Roye, the director of the SEC's division of investment management, in a letter to Barbara D. Bovbjerg, director of the education, workforce and income security issues at the GAO. "The Commission staff is considering recommending modifications to the Commission's proposals that should mitigate against certain circumstances that could potentially adversely affect pension plan participants."

Actual Harm

The report did not find that investors in pension plans or other long-term shareholders were harmed any more than other mutual fund investors by the abusive practices of timers and late traders. "Ultimately, the effects of late trading and market timing on the savings of retirement plan participants and other long-term fund shareholders is a function of which funds they invested in and for how long," the report states.

The study was done at the request of the House Ways and Means subcommittee on Oversight and was conducted between March and June. It included a review of academic studies about the effects of late trading and market timing on mutual funds as well as interviews with representatives from mutual fund companies, plan recordkeepers, SEC and Department of Labor officials.

"Because late trading and market timing have negatively affected pension plan participants and other long-term investors, we support the SEC's efforts to stop these abusive practices," the report states. "However, in certain circumstances, some pension plan participants may be more adversely affected by the SEC's proposed regulations than other mutual fund investors if they were to be adopted as proposed. Amending the proposed regulations to mitigate these potentially negative effects on pension plan participants, as SEC staff are now considering, seems a sensible approach."

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