January 22, 2004
I am an investment advisor representing many small and medium-sized investors in Michigan. We help our clients manage their 401k's, mutual funds, and individual stocks. We agree that post 4:00 p.m. trading should be banned. However, we are concerned that many innocent investors will be negatively affected by the proposal to make sure all trades are presented to mutual funds prior to 4:00 p.m. While it sounds like a simple solution to the illegal and unethical trading after hours, it will have a negative impact on the 99.9% of other investors who are law-abiding and faithful long-term investors. This is a classic over-reaction by regulators with unintended consequences. New regulations intended to protect investors should not unnecessarily restrict those investors and put them at a disadvantage to other (stock) investors, especially when there are other better approaches.
A relatively large number of investors have 401k's 403b's and mutual fund investments. While they don't understand how they will be impacted now, they will come calling later about the unfair impact upon them of the proposed regulations. Law-abiding investors do not want to be put at a disadvantage to prevent the actions of a small number individuals promoting illegal activity. Direct purchase fund holders should not be put at an advantage over 401k participants or investors with third party custodians.
If the post-4:00 p.m. problem is solved by requiring that all trades at mutual funds be presented prior to 4:00 p.m., many of investors will be forced to make changes in their fund holdings much earlier in the day or maybe even the prior day, which can be a definite disadvantage in today's volatile markets. Currently, because of internal processing issues, most mutual funds or third party custodians have an order cut-off between 3:00 and 4:00. This allows investors to have a reasonably good sense of the price they will receive for their shares since the market close is an hour or less away. The proposed "4:00 p.m. hard close" will inevitably require institutions to push their order cut-off times back at least 1 to 3 hours (depending upon the institution) to ensure that all orders are completed. This puts mutual fund investors at a substantial disadvantage to stock investors and large institutions.
I believe that a better solution lies with clear regulatory compliance focus on the issue of non-compliance with an existing 4:00 trading close rather than trying to jury-rig the operational aspects of the market close as it affects mutual funds. I have six recommendations:
First, we should have mutual fund CEO's and third party custodian CEO's sign off each quarter with their financial submissions to the SEC that they have not permitted late trading and redemption fee waivers for rapid trading. This approach is similar to regulations requiring corporate CEO's to sign off on their financial statements' accuracy when filed with the SEC. Second, regulators or industry officials should establish "best practices" approaches in these areas of offensive behavior and send them to directors and management of mutual funds and third party custodians. Third, these issues should be made a focus of compliance efforts with mutual funds and custodians. Fourth, violators of these policies should be fined, punished and banned from the industry. Fifth, time stamp the trades to prove they have been entered on a timely basis. Sixth, if people believe that there are too many ways around the hard 4:00 close, put a reward of $X for reporting every trade entered after 4:00. This will reward the watchdogs and encourage people to turn in violators.
I believe that these efforts in combination can clean up 99.9% of the problems without the unintended consequences for millions of mutual fund investors.
K. Larry Hastie, M.B.A., Ph.D.