As fund companies and their intermediaries continue to grapple with the finer points of the Securities and Exchange Commission's looming redemption fee rule, industry groups have been working on ways to make complying less complicated.
The rule, officially called 22c-2, has been controversial since its March 2005 passage. Slated to take effect on Oct. 16 of this year, it allows fund companies to impose a redemption fee of as much as 2% on shareholders who sell their stakes within one week of purchase. Meant to detect market timers whose trades might be illegal or expensive to long-term shareholders, the rule also poses several logistical challenges for intermediaries and offers little guidance.
"One of the main questions we were getting from our members was, What is everyone else doing? What guidelines should we follow?'" said Larry H. Goldbrum, general counsel at RG Wuelfing & Associates and chairman of the government relations committee for The SPARK Institute, an organization of retirement plan service providers with headquarters in Simsbury, Conn.
The SEC's rule has left details of just what information is required, how often it is requested and in what format it is delivered to the discretion of fund companies, which are then responsible for determining that none of their internal market-timing policies have been breached.
"The onus will be on the fund companies," said Tamara Salmon, senior associate counsel with the Investment Company Institute in Washington. "The SEC will come down on the mutual funds, not the intermediaries, to demonstrate that they are in compliance."
The rule further requires that fund companies negotiate and have in place agreements with all of their intermediaries before the rule takes effect, an undertaking that has been projected to cost at least $2 billion industry-wide. Progress on this complicated and potentially costly endeavor has been slow as fund companies and, therefore, their intermediaries look to the SEC for clarification before diving in.
In the meantime, The SPARK Institute is one of several groups to have lobbied the SEC for an extension before the rule takes effect. In May, The SPARK Institute asked the SEC to extend the deadline for the agreements to be in place until April 30, 2007 and until July 31, 2007 before recordkeepers would be expected to provide data to funds (see MME 6/19/06).
The group cited a survey of its members in which 70% said they could not meet the Oct. 16 deadline, and 39% said that doing so would require a commitment of "significant additional resources." SPARK's report also noted that many of its members had yet to receive contracts from the mutual fund companies with which they work.
Likewise, in an April 10 letter to the Commission, the Investment Company Institute, which has issued statements in support of the rule, requested an extension of at least six months, while the National Association for Variable Annuities of Reston, Va., has lobbied for an 18-month delay, so that insurers can determine fees and devise a way to accommodate the automatic rebalancing programs that many plans undertake without triggering redemption fees from fund companies.
Salmon notes that while both insurers and retirement plan providers have expressed concern that redemption fees will only eat away at the gains that would otherwise go to customers, there is a way to avoid such expenses. "They can choose funds that don't have redemption fees," Salmon said. The rule, as revised from its original form, leaves the decision of whether to impose fees to deter frequent traders up to each fund's board of directors.
As the SEC considers these requests and continues to fine tune the rule and clarify its terminology, industry groups like The SPARK Institute are moving forward with template contract language and best practice guidelines to ensure their constituents are prepared.
"This is a set of standards that at a minimum would be a starting point for the industry," Goldbrum said.
The guidelines, published on June 29, come from consultations with both retirement recordkeepers and fund companies, in an effort to devise a system that is amenable to both, and still within the parameters of the SEC rule.
"There were unlimited possible variations of how fund companies want to enforce market-timing restrictions and how the monitoring is done," Goldbrum said. "This kind of limits the field."
As written, the best practice guidelines call for recordkeepers to be required to monitor only those transactions that participants request and that offer the potential for market timing or excessive trading abuse, and exempt all those purchases and redemptions under $1,000. The guidelines also call for round-trip monitoring periods to be defined as 60 days, and suggests software development guidelines.
"Recordkeepers should program their systems in order to also accommodate a 30- or 90-day identification period that may be required by certain funds," the SPARK guidelines note. "However, unless the needs of the fund are so unique as to warrant an exception, recordkeepers should encourage the funds to accept the 60-day period in order to minimize the number of alternatives required for compliance."
The guidelines also suggest that the monitoring period be defined as the 60-day span immediately following a round-trip trade, or the two calendar months following such a trade, whichever a recordkeeper's computer system is better fit to handle. Furthermore, the guidelines suggest that the rolling period would allow no more than six round trips annually before encroaching on trade restrictions.
Participants that exceed the appropriate number of round-trip trades should be restricted from exchanges or purchases for 60 days after the offending trade, and must be notified in writing of the date by which they will be allowed to trade again, according to the guidelines. Restoration of those privileges should be automatic, the guidelines say.
As for how recordkeepers report trading activity to funds, SPARK calls for a monthly report delineating any restrictions imposed during that month, and providing an annual compliance report to be prepared by an outside auditor.
"Where the recordkeeper provides such report to the funds, it should not be necessary to provide information-sharing reports to the funds on a regular basis during the year," the guidelines note, although it makes exceptions for fund requests for "good cause," defined as instances where the recordkeeper has not agreed to uphold fund policies, for example, or where the fund has seen unusual volume. Furthermore, the proposed best practices call for funds to be permitted to ask for any record of a 90-span for up to a preceding year from the date of the request.
Finally, the guidelines call for recordkeepers to clearly communicate their standards and practices to funds, their plan sponsors, and, in enrollment documents, to participants. The information should again be furnished to participants through trade confirmations, or regular account statements, as well as to all parties before monitoring begins.
The guidelines, like the sample contract language, are meant to serve as a basic framework, and a means to control the cost to intermediaries of implementing the rule, which The SPARK Institute estimated, could be between $30 million and $50 million annually, between the time, software and system changes that would be required, according to a May 1 letter submitted to the SEC.
The guideline document "answers a lot of questions and helps bring consistency," Goldbrum said. So far, the response has been good, he added. By the time the SEC issues its final rule - the Commission is expected, ultimately, to extend the deadline before summer's end - Goldbrum expects it will both offer further clarity and still fit well with the SPARK guidelines.
Until then, The SPARK Institute, ICI, NAVA and scores of fund companies and service providers continue to work on guidelines for other sectors of the industry, as well as tools to support it.
The National Securities Clearing Corp., a subsidiary of the Depository Trust and Clearing Corp. of New York, has been consulting with companies in all parts of the industry to adapt its network, which serves a commanding majority of the industry's market share, to ensure seamless data collection and delivery between broker/dealers and fund companies. The system is expected to be available by early August, according to a June 26 DTCC webcast.
Still, the rule poses many challenges for funds and their intermediaries, not the least of which is the contract negotiation process. While guidelines and templates, like those published by the SPARK Institute, offer a solid start, each fund is unique, and may have their own needs, Salmon said.
"There are no uniform ways in which mutual funds are sold, or the way they are distributed and no uniform market-timing policies," she said. "While uniformity is an aspiration, I don't see it in this area."
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