The Securities and Exchange Commission has decided to take another look at a portion of its new redemption fee rule, a development that would likely relieve a tremendous burden from the shoulders of the nation's fund companies.

Officially known as Rule 22c-2 and an amendment to the Investment Company Act of 1940 adopted last March, the mandate is designed to sniff out instances of market timing that might be illegal or costly to long-term fund shareholders. When the SEC originally proposed the rule in the wake of the scandal, it called for fund companies to impose a 2% redemption fee on shares redeemed within five days of purchase.

But bowing to industry concerns over the cost of imposing redemption fees, the SEC passed what it called "a less restrictive, more flexible" rule that left it to fund boards and their chief compliance officers to determine whether a fee should be imposed on shareholders that sell their stakes within seven days of purchase.

Perhaps sensing further backlash once funds started implementing the rule in its entirety - some consulting firms pegged the costs as high as $2.3 billion for industrywide implementation, while one fund complex said individually it would cost $8.5 million or more - the SEC left the door open last year for additional tinkering.

Now it appears ready to do just that, as on Feb. 28 the regulator announced that it would seek industry comment on possibly scaling back the number of information-sharing agreements that 22c-2 demands funds hammer out with financial intermediaries. If the rule were to remain unchanged before its Oct. 16, 2006 compliance deadline, funds would have to enter into legally binding agreements with literally thousands of financial intermediaries, many of which are buried in huge omnibus accounts at a fund's brokerage house. That would include, for instance, a 401(k) that might be sponsored by, say, a neighborhood dentist's office with just a handful of employees.

Among the more than 100 comment letters the SEC originally received regarding 22c-2, many "emphasized that the task of identifying these intermediaries, as well as negotiating agreements with them, will be costly and burdensome," the new proposal indicates. It also adds that this glitch "was an unintended consequence, which [the SEC] did not foresee."

Therefore, the proposed amendment seeks "to exclude from the definition of financial intermediary' any intermediary that the fund treats as an individual investor," such as a retirement plan.

"The rule needed to be fixed, and this appears to be a fix we can live with," said Elizabeth Krentzman, general counsel at the Investment Company Institute in Washington. "This addresses the expense of parsing through many thousands of accounts and determining which is an intermediary, and then having to reach out to those intermediaries, many of which would probably not respond in kind."

For example, T. Rowe Price, a $145.5 billion money manager in Baltimore, indicated in its comments on 22c-2 that it has more than 1.3 million accounts, which represents nearly 320,000 tax identification numbers, that are not registered as regular persons and could be considered intermediaries under the rule.

Fenimore Asset Management, a boutique value manager with just over $2 billion in assets under management, is pleased by the SEC's decision. According to officials at the Cobleskill, N.Y.-based firm, the amendment would remove the firm's primary objection to the rule.

"It's a good move," said Charles Richter, Fenimore's CCO. "They weren't clear in their definition of who would be considered an intermediary, and by narrowing it, they've thrown out the people who won't be impacted."

As an aside, Richter noted that the rule would also provide Fenimore with important information about investors in omnibus accounts that it previously couldn't access.

"It's opened up a lot of data for us," Richter said.

In addition, according to the SEC, the amendment "would address the rule's application when there are chains of intermediaries," or those instances where, for example, the holder of a variable annuity could be considered a shareholder because their insurance company has that money invested in the fund. The amendment would revise the rule "to provide that a fund enter into a written agreement with only those intermediaries that submit orders to purchase or redeem shares directly to the fund."

Finally, the amendment would "clarify the effect of a fund's failure to obtain an agreement with any of its intermediaries." In other words, as New York fund giant OppenheimerFunds observed in its original commentary on 22c-2, if an intermediary refuses to enter into an agreement, the fund would shoulder a toothless enforcement burden, as well as legal costs. The amendment would give funds the authority to prohibit additional purchases by those intermediaries.

The SEC estimates that with the amendments, the financial impact of 22c-2 to funds and their intermediaries in the first year would be about $274.5 million in one-time start-up costs and annual operation costs of an estimated $161.5 million. Over the first three years, the rule would cost about $253 million. In its original draft of 22c-2, the SEC estimated that that three-year number would be roughly $630.8 million. Thus, reducing the number of intermediaries fund companies would have to deal with would save the industry $378 million in the first three years.

But not everyone thinks the amendment proposal is a silver bullet.

"The SEC is making some changes that are responsive to our comments, which is good, but there is still a great deal of difficulty from a retirement plan perspective," said Brain Graff, executive director of the American Association of Pension Professionals & Actuaries, a Washington lobbyist that represents more than 5,400 of the nation's defined benefit and defined contribution plan professionals.

"It would be an overstatement to say that they have addressed all of our concerns," said Graff, who plans to take advantage of the SEC's comment period on the amendment proposal, which is open until April 10. "There are still firewall concerns, size of data concerns, data storage concerns, a myriad of technological concerns."

Recordkeepers like Graff's members are chiefly worried about how the sensitive investor data, such as tax identification numbers, can be safely stored and passed between intermediaries and funds.

Regarding that operations dilemma, ICI officials reported that the Depository Trust & Clearing Corp. should be releasing an announcement about the Standardized Data Reporting Solution it's working on very soon, no later than mid-March. Testing for the new facility should be available in the summer, and full production would be available to funds and intermediaries prior to the redemption rule's Oct. 16 deadline.

Fund operations outsourcer SunGard of Wayne, Pa., and San Francisco brokerage house Charles Schwab are currently operating proprietary information exchange technologies, the SEC said.

The ICI, which intends to ask the SEC to reconsider its Oct. 16 compliance deadline for 22c-2, also recently made available a sample contract developed with the National Securities Clearing Corp. that fund firms and intermediaries can use to draft information-sharing agreements.

Whatever the final outcome, there's a chance the SEC could revisit other elements of the redemption rule. It hinted in the proposed amendment that many commentators previously expressed a desire for a uniform redemption fee standard. The SEC said it is considering those views, but isn't proposing such a measure "at this time."

(c) 2006 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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