Subject: File No. s7-11-04
|Re:|| Mutual Fund Redemption Fees
Release No. IC-26782, File No. S7-11-04
Dear Mr. Katz:
Delta Data Software, Inc. (Delta Data) appreciates the opportunity to comment in response to the new Rule 22c-2 (the “Rule”) that the Securities and Exchange Commission has adopted under the Investment Company Act of 1940. By way of background, Delta Data provides application software for financial intermediaries for automation and control of internal processes around their mutual fund business. Delta Data clients custody mutual fund assets in excess of four hundred billion dollars. One of our applications allows firms to age shares and calculate short term redemption fees on sub-accounts that are traded in omnibus accounts at the fund.
As a software vendor, we will withhold comment on the business issues of the Rule feeling that this is best left to the intermediaries, investment companies and various trade organizations representing these firms. However, we will be charged with providing a software solution that will enable our clients to comply with the various aspects of the Rule. It is in this light that we comment on some of the more perfunctory aspects of implementing the Rule.
At a very high level, software development involves defining a specific set of business rules, storing the rules and the key data elements required to perform the calculations, writing programs that manipulate the data based on the rules and then storing the resulting data in a table structure for reporting, inquiry or the creation of transactions. Software programs must be based on specifics. One cannot program generalities or assumptions. It is upon this theorem which we submit the following comments.
FIFO Accounting and Exempt Purchases
Most share lot accounting systems have the ability to process what is commonly called “free shares”. Free shares are exempt from fees and most commonly arise from shares purchased with reinvested dividends or capital gain distributions. Redemptions are always applied first against any free shares, regardless of age. Any remaining shares from a redemption would then be applied using normal FIFO share lot accounting where they would be matched against the oldest share lots. Many short term redemption fee policies issued by funds are silent as to the accounting for reinvested dividends whereas their CDSC policies are usually clear that reinvested dividends/cap gains are considered free shares.
Most CDSC fees and many short term redemption fee structures also allow for “exempt redemptions”. These are redemptions that do not have fees imposed regardless of the age of the purchase lots they are being applied against. Examples would be redemptions due to death or disability. Now we are starting to see short term redemption fee policies that are making provision for “exempt purchases”. The most common examples are shares purchased in qualified retirement plans attributable to participant payroll contributions or employer contributions. When redemptions are applied against these specific share lots, the redemption is not subject to a fee. As long as these “exempt purchases’ are treated like free shares, there should be no problem in accounting for them as they would be treated just like reinvested dividends or capital gains. However, if they are to be aged and used up under normal FIFO accounting, there would be serious problems with systems being able to process these exempt purchases. Some funds, such as Vanguard, clearly state in their prospectus that the exempt purchases are to be used up first regardless of age, thus following normal accounting for free shares. Many other funds, however, are silent on how these exempt purchases are to be applied.
We recommend that funds clearly state in their short term redemption fee policy if reinvested dividends and capital gain distributions are to be considered free shares or are subject to the short term redemption fee. We also recommend that funds clearly state that exempt purchases are to be treated in the same as free shares and not aged.
De Minimis Fee Amount or Transaction Amount
You have requested comment as to whether the Rule should permit or require funds to waive redemption fees under a certain dollar amount. We would recommend that if a de minimus waiver is allowed or required, that it be expressed as a minimum trade amount rather than a minimum fee amount. A fund that has six different rates and a single de minimus fee amount will have six different minimum trade amounts. A de minimus fee amount will be more confusing to shareholders and also will complicate the calculation more than a single minimum trade amount. A trade de minimus amount can be excluded from the fee calculation process based on the size of the trade, where a de minimis fee rule would require a calculation before determining if the trade is exempt from the fee. It is our experience that most trades are dollar certain. Anyone could quickly ascertain if a fee should have been imposed on a trade if the de minimis is expressed in the dollar amount of the trade. For a share certain trades, most systems can easily convert share certain trades to the dollar equivalent. To determine if a share certain trade should be exempt from a fee will require three steps if it is based on a minimum fee amount including knowledge of the specific redemption fee rate for a CUSIP. Your earlier proposed rule on mandatory redemption fees referenced a minimum trade amount of $2,500.00. We recommend that funds define de minimis transactions as a minimum trade amount in dollars rather than a minimum fee amount.
Calendar Day Holding Periods
We support the change between the Rule and the original proposal whereby the redemption period is now expressed in calendar days rather than business days. We recommend that funds always express the holding period in calendar days. Some funds are currently expressing the holding periods in months. From a purely mathematical average perspective, a month is 30.416 days since a month could actually be 28, 29, 30 or 31 days. Here again, expressing the holding requirement in calendar days removes any doubts about the term of the holding period.
The format for the submission of shareholder and trading information should be standardized and all intermediaries should be required to follow the standardized format. This format should be developed by industry groups and should also be available for submission through DTCC’s Networking service.
We very much appreciate the opportunity to submit these comments and hope the Commission will find our comments constructive. Please refer any questions to the undersigned at 706-324-0855, Ext 145.
L. Burton Keller, CPA
Senior Vice President
Delta Data Software, Inc.