The Financial Planning Association

FPA Government Relations Office
1615 L Street, N.W., Suite 650
Washington, D.C. 20036
Voice: 202.626.8770
Fax: 202.626.8233
Web site:

By Electronic Mail

February 6, 2004

Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Re: Release Nos. 33-8343; IC-26287; File No. S7-26-03; Disclosure Regarding Market Timing and Selective Disclosure of Portfolio Holdings

Dear Mr. Katz:

The Financial Planning Association ("FPATM")1 is pleased to submit comment with respect to rules intended to identify illegal late trading, discourage excessive trading that dilutes the value of shares held by other investors, and encourage equal access to information on mutual fund portfolio holdings. In the wake of widely reported illegal trading activity and other abuses in the mutual fund industry, FPA strongly supports the proposed Rule for mutual funds and variable annuities.

We believe it would be appropriate for the SEC to consider in future rulemakings the beneficial role that financial planners play in offering to clients a disciplined approach to mutual fund investing. 2 We describe in this comment letter how the Rule benefits professional advisers in performing due diligence as well as how it benefits the public. A major part of the professional services offered by many FPA members is making recommendations to clients, or assisting clients in their own research, concerning the selection of suitable investments from the more than 15,900 mutual funds currently available. In order to create investment portfolios designed to assist a client in reaching personal and financial goals, this intermediary function between the mutual fund companies and the investing public requires that financial planners have access to timely and accurate information. Planners need to be assured that all relevant rules are being observed by both the fund companies and active traders.

As fiduciaries under the Investment Company Act of 1940, mutual fund companies must not favor one shareholder over another, no matter how many shares are held by one investor. A requirement in the Rule disclosing favoritism of a mutual fund toward certain large investors in connection with disclosure of portfolio holdings should help discourage such activity, strengthen the fiduciary obligation of fund companies to all shareholders and, over time, restore investor confidence in the mutual fund industry. It should be noted that registered investment advisers are subject to disclosure and fiduciary standards of the Investment Advisers Act of 1940, offering a consistent "flow through" of protections to clients holding mutual fund shares. Most FPA members are affiliated with investment advisory firms, and are also subject to the professional standards of the CFP Code of Ethics and Professional Responsibility.3

The disclosure requirements in the proposed SEC Rule would assist FPA member compliance with Rule 704 of the CFP Code of Ethics, which requires CFP® practitioners to undertake a "reasonable investigation regarding the financial products recommended to clients."4 In light of continuing revelations of systemic illegal trading activity in the fund industry, compliance with Rule 704 is made more difficult absent detailed information on emerging regulatory problems in the fund industry. Improved disclosure of fund short-term trading policies, their procedures for identifying late trading, and details of a fund's equity holdings (for the purpose of identifying style drift - not market timing),5 would greatly assist financial planners in evaluating fund options for their clients and in satisfying the general requirements of Rule 704.

In a broader industry context, this proposal will aid financial planners and many other investment advisers who serve as fiduciary agents to 401(k) and other ERISA plans.

Because of the spreading mutual fund scandal, they are now on notice that their fiduciary duty of care requires more than just the traditional diagnostic tools needed to evaluate risk, performance, costs, and role in a portfolio. They are beginning to ask fund management to explain fund practices with respect to market timing and illegal late trading; and what steps, if any, fund management is taking, in light of the investigations, to correct any potential abuses. The proposed Rule would make it easier for ERISA plan fiduciaries to identify fund management's controls with respect to these trading activities.6

State treasurers who sponsor Section 529 college savings plans also would find disclosure information useful as some states begin to fire and replace fund companies that have been implicated in SEC and state investigations.7 College planning on behalf of clients, in turn, requires advisers to pay special attention to the status of 529 plan managers during an investigation, and to examine the resulting tax implications and other costs if a state replaces a 529 plan.

Similarly, Rule 201 of the Code of Ethics requires CFP practitioners to "exercise reasonable and prudent professional judgment in providing professional services."8 The ongoing mutual fund investigations have prompted considerable discussion in financial planner circles - including formal education sessions -- about when it is prudent to transfer client assets out of a mutual fund. Common examples include when a fund experiences significant outflows as the result of a highly publicized investigation9 or when its status as a 529 plan becomes controversial. Better disclosure of fund trading restrictions will help financial planners better evaluate a fund's policies with respect to short-term trading and disclosure practices.

FPA offers specific comments below concerning the Commission's proposal.

A. Short-Term Trading and Market Timing

The proposed Rule would, among other things, require mutual funds to develop certain disclosure policies and procedures with respect to frequent purchases and redemptions of fund shares, and the risks involved in market timing. FPA supports the disclosure requirements as a way of placing mutual funds on record regarding their trading policies and in assisting a financial planner's qualitative evaluation of a fund's governance structure. It would be illusory to think, however, that the proposed disclosures under the Rule will be more than marginally helpful to consumers. Anecdotal comments of financial planners who must carefully evaluate their clients' financial sophistication during the financial planning process suggest otherwise. Studies also indicate the vast majority of shareholders fail to read fund prospectuses. 10 Adding to an investor's reading burden, the Rule would include up to 30 new categories of information in a prospectus. Nonetheless, for reasons cited previously, FPA strongly supports the addition of this information to the mutual fund prospectus, in particular the following specific disclosures:

  • Describing the risks of short-term trading and how systemic activity could increase costs for other shareholders;

  • Stating whether the mutual fund's board has adopted policies and procedures with respect to market-timing, and if not, an explanation;

  • Whether the fund has policies discouraging short-term trading, including details on when redemption fees are charged, minimum holding periods, etc.;

  • The right of a fund to reject frequent trading by a shareholder; and

  • Any exceptions to the above policies permitted by the mutual fund.

B. Selective Disclosure of Fund Portfolio Holdings

FPA strongly supports the requirement that mutual funds at a minimum disclose any favoritism shown to larger investors when providing details on a fund's portfolio holdings. We would prefer to see the SEC ban this practice, but assume that forcing light on questionable disclosure practices would allow the marketplace to eliminate the problem. Equal access to such information is clearly a fairness issue for small investors and independent financial planners. Most FPA members' clients are small investors. A 1999 survey indicated clients of CFP® certificants had average incomes of $131,000, allocating 10 percent or less of their annual income to savings or investments.11 Consistent with this approach, FPA also supports application of Regulation FD to open-end mutual funds with regard to any mutual fund practices that permit selective disclosure.

FPA generally supports all of the disclosure requirements related to the above activities in proposed Item 12 of the Rule and, in particular, mutual fund policies that limit disclosure of equity holdings to different categories of persons; a description of those restrictions and the categories of persons such as individual investors, institutional investors, third-party service providers, rating organizations, and hedge funds; the fund company personnel authorized to make such disclosures; and disclosure of conflicts of interest with respect to receipt of compensation by the fund company or personnel, directly or indirectly, for selective disclosure.

We believe such disclosures should be placed in the prospectus, and only in the Statement of Additional Information ("SAI") if the SAI is available on the mutual fund's web site.

In conclusion, FPA strongly supports the proposed Rule. As part of the SEC's overall rulemaking activity to restore investor confidence in the mutual fund industry, we believe the specific objectives of this Rule -- to level the playing field with respect to disclosure of fund holdings to all third parties, to help educate investors on potential problems with market timing, and to discourage systemic short-term trading where the costs are borne disproportionately by other shareholders - will have an overall beneficial effect on consumer protection.

We would be pleased to provide any additional information requested by the SEC. Please do not hesitate to call the undersigned at (202) 626-8770.


Duane R. Thompson
FPA Group Director, Advocacy

1 The Financial Planning Association is the largest organization in the United States representing financial planners and affiliated firms, with approximately 28,000 individual members. Most are affiliated with registered investment adviser firms registered with the Securities and Exchange Commission ("SEC" or "Commission"), state securities administrators, or both. FPA is incorporated and maintains an advocacy office in Washington, D.C., with administrative offices in Denver and Atlanta.
2 FPA members hold investment management discretion over an estimated $600 billion in fund assets on behalf of 7.8 million clients. As noted above, many financial planners also make asset allocation recommendations as part of a financial plan but do not provide continuous and ongoing supervision of client-owned mutual funds, stocks, bonds, etc., or otherwise hold discretion.
3 The CFP Code of Ethics and Professional Responsibility (hereinafter "Code of Ethics") requires disclosure of material information relevant to the professional relationship, "Rules that Relate to the Principle of Fairness," rules 401(a) and (b), at 9-10. CFP® certificants also must "act in the interest of the client," "Rules that Relate to the Principle of Objectivity," Rule 202, at 9.

CFP®, CERTIFIED FINANCIAL PLANNERTM and the federally registered CFP (with flame logo) are certification marks owned by the Certified Financial Planner Board of Standards, Inc. These marks are awarded to individuals who successfully complete the CFP Board's initial and ongoing certification requirements. A subsidiary Board of Professional Review is responsible for disciplinary actions resulting from violations of the Code of Ethics.

4 Code of Ethics, "Rules that Relate to the Principle of Diligence," Rule 704, at 14.
5 "Style drift" is an industry term used to describe a conflict between the actual equity holdings and the stated investment objectives of a mutual fund. Style drift occurs when the portfolio characteristics of a fund's holdings, such as average market capitalization, profit/earnings ratio, sector weightings, or bond maturities, change from historical patterns or portfolio objectives. When this is undetected or not reported in a timely manner by the mutual fund, neither shareholders nor their advisers can properly evaluate their holdings and rebalance the portfolio accordingly, even if the style drift works in favor of the investor. FPA commends the Commission on recent rule changes that require mutual funds to more accurately describe the investment style if the fund name suggests a growth, value, small cap orientation, etc.
6 See "Plan Fiduciaries Should Beef Up Safeguards on Mutual Funds, Before Participants React," by David B. Brandolph, Daily Report for Executives, Bureau of National Affairs, Inc., Feb. 5, 2004, at C-1.
7 See e.g. "Oregon Delays Vote to Replace Strong on College Fund," by Arden Dale and Kathy Chu, Dow Jones Newswires, Jan. 27, 2004.
8 Code of Ethics, "Rules that Relate to the Principle of Objectivity," Rule 201, at 9.
9 See e.g. "Morningstar Expands Warning List; Research Firm Recommends Withholding Cash or Selling Funds Involved in Scandal." By Yuka Hayashi, Dow Jones Newswires, Feb. 3, 2004.
10 A recent news article suggests only 1 percent of mutual fund shareholders actually read the prospectus. See "Bite the bullet, read the fund prospectus -- it will pay off," December 28, 2003, a USA Today article featured on
11 See "First Annual CFP Practitioner Survey," by Certified Financial Planner Board of Standards, Summer 1999, at 10.