SEC Keeps Timing Fees Optional
Under pressure from sellers of mutual funds, the Securities and Exchange Commission backed off Thursday on a controversial plan that would have imposed fees to discourage “market timing” by favored traders that can hurt average investors.
Market timing -- the rapid, in-and-out trading of shares -- was at the center of the mutual fund scandal uncovered by New York Atty. Gen. Eliot Spitzer in 2003. The SEC voted last year to seek public comment on a rule that would require funds to levy a 2% fee on short-term trades.
But on Thursday, the commission voted 5 to 0 to instead require mutual funds to obtain more information from third parties, such as broker-dealers and retirement plans, about potential market-timing activities.
While not mandating any fees, the new rule requires the boards of fund companies to consider whether special charges of up to 2% should be imposed for shares sold within seven days of their purchase.
Russ Kinnel, director of fund research for Morningstar Inc., said requiring fees would have made it “much more difficult” for traders to conduct market timing.
“Here we are a year and a half after the scandals and all we’ve got so far is a voluntary measure,” Kinnel said.
Market timing can yield big profits for hedge funds and other speculative traders, regulators say, but the excess trades drive up transaction costs borne by all shareholders, including small buy-and-hold investors.
Investigations by the SEC, Spitzer and other state regulators found that mutual funds often allowed market timing in violation of their own stated policies against it.
The $8-trillion mutual fund industry has been divided over mandatory redemption fees as a way to discourage abusive trading. The industry’s major trade association, the Investment Company Institute, has supported the approach as a way to curb market timing and bolster public confidence in mutual funds. A minority of funds currently assess redemption fees of some sort.
While describing Thursday’s vote as “an important step forward,” the Investment Company Institute’s president, Paul Schott Stevens, said he remained concerned “that market timers will still be able to play ‘catch us if you can’ with mutual funds.”
Some of the most vehement opposition to fees has come from fund marketers and professional investors who profit from frequent transactions. These and other critics attacked mandatory fees as imposing burdensome record keeping and impeding investors’ freedom to trade funds as they pleased.
An organization representing investment advisors Thursday applauded the SEC for not making such fees mandatory.
The SEC “has reinforced the high bar that funds must exceed to impose these costs on investors,” the National Assn. of Active Investment Managers, which represents 150 firms managing $14 billion, said in a statement.
Statements by the five SEC commissioners Thursday reflected ideological tensions on the panel of three Republicans and two Democrats.
Chairman William H. Donaldson, a Republican, said that special trading fees may sometimes be appropriate, but that it would be a mistake to impose “a one-size-fits-all approach.” Letting fund boards decide “makes a great deal of sense,” he maintained.
Democrats, while supporting the watered-down plan, expressed something less than optimism.
“The less restrictive, the more flexible alternative that we have today is worth trying,” said Commissioner Harvey J. Goldschmid. “But I think we’ll have to keep our eye on it to see if it’s working.”
Under the new measure, mutual funds will be required to set up information-sharing agreements with brokers and retirement-plan administrators to help the funds identify shareholders who may be engaging in improper trades. Funds will have broad discretion in how to carry out such arrangements. The rule will take effect in 2006.
“I think this is a call to the industry to be responsible,” said Democratic Commissioner Roel C. Campos. It is in the “enlightened self-interest” of funds to work with their marketers to prevent trading abuses, he said.
Commissioner Paul S. Atkins, a Republican who denounced the proposal for mandatory redemption fees when it was unveiled in February 2004, Thursday described the new plan as a “great improvement” but warned that it might still saddle companies and other fund marketers with substantial costs.
The SEC’s staff estimated that the rule would cost $630 million over the first three years.
Republican Commissioner Cynthia A. Glassman said the ultimate way to protect investors against market timing was for funds to do a better job of keeping their prices up to date. Fund companies have widely varying practices of updating their share values to reflect changes in foreign stock prices they hold, a factor that some traders exploit in frequent trades.
More accurate, up-to-date pricing should be the “primary method” for solving the problem of market timing, she said.
