February 6, 2004

Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20459-0609

Re: File No. S7-27-03, Proposed Amendments
to Rules Governing Pricing of Mutual Fund Shares

Dear Mr. Katz:

National Securities Clearing Corporation ("NSCC") appreciates the opportunity to comment on the proposal by the Securities and Exchange Commission (the "Commission") to amend Rule 22c-1 under the Investment Company Act of 1940 (the "Investment Company Act").1 NSCC is a clearing agency registered with the Commission under Section 17A of the Securities Exchange Act of 1934 (the "Exchange Act").

As is discussed more fully below, NSCC is prepared to modify its systems to incorporate into its Fund/SERV®2 system a centralized "time-stamping" capability as contemplated in the proposed amendments to Rule 22c-1. NSCC agrees that, if the Commission considers it necessary to require the use of a more centralized capability to validate the time of receipt of a mutual fund order for purposes of determining the net asset value at which it should be completed, it is appropriate to have that capability incorporated into Fund/SERV as the most effective and least disruptive approach to this requirement. NSCC also recognizes, however, that moving to a centralized "time-stamping" approach will impose some limitations on the flexibility of all investors in mutual funds, and will eliminate the ability to conduct certain transactions on a same-day basis - negative effects that could be eliminated through the implementation of reinforced approaches to time-stamping at the intermediary level. We recognize that the Commission will have to judge whether those adverse impacts on the broad population of investors in mutual funds are outweighed by the benefits of the proposed amendments. NSCC is prepared to work with the Commission, mutual fund companies and the investment community to implement the Commission's determinations as to the necessary solutions to this industry problem.

NSCC's Role as the Mutual Fund Clearing House

NSCC provides centralized clearance, settlement and information services for a substantial majority of U.S. inter-broker trades in equity securities, corporate and municipal bonds, exchange-traded funds and unit investment trust shares. In addition, NSCC offers centralized information and settlement services for mutual fund and insurance and annuity transactions by linking mutual funds and insurance carriers with broker-dealers, banks and other distributors of mutual funds and insurance products.

As indicated in the proposing release, NSCC is the only registered clearing agency that provides an automated system for processing mutual fund orders, Fund/SERV. NSCC's Fund/SERV system receives order information from broker-dealers, banks, 401(k) plan administrators and other NSCC participants and transmits the information to the appropriate fund. The fund may confirm or reject each order and send the corresponding order confirmation or rejection data through Fund/SERV to the appropriate broker-dealer or other NSCC participant3.

NSCC's Fund/SERV system provides cost-effective and efficient solutions to the mutual fund marketplace by centralizing and automating the communication of data in the mutual fund order clearance and settlement process and by providing standardized formats for mutual fund order data. NSCC is an industry utility which is owned and governed by the broker-dealers, banks, mutual funds and other financial institutions which use its services4. It does not pay dividends on its capital stock and it rebates excess revenues to its users. In 2003, NSCC processed over 87 million fund transactions at a value of $1.54 trillion. NSCC processed a daily average of 345,000 fund transactions at a value of $6.1 billion in 2003. Daily mutual fund transaction volume reached a peak of 661,847 transactions processed through Fund/SERV on January 20, 2004.


The Commission's proposed amendments to Rule 22c-1 provide that an order to purchase or redeem shares in a mutual fund (a "mutual fund order") would receive the current day's price only if the mutual fund, its designated transfer agent or a registered clearing agency (an "authorized time-stamping organization") receives the order by the time that the mutual fund has established for calculating its net asset value (e.g., 4:00 p.m. Eastern time)5.

If the proposed amendments are adopted, NSCC agrees with the Commission that registered clearing agencies should be included among the entities authorized to time-stamp mutual fund orders for purposes of establishing the time of receipt of a mutual fund order.6 NSCC can, and is willing to, perform such a role. As a registered clearing agency, NSCC is subject to comprehensive regulation and oversight by the SEC and is neutral with respect to which price a fund assigns to a mutual fund order. In addition, including registered clearing agencies among authorized time-stamping organizations would permit fund intermediaries to continue processing mutual fund orders through Fund/SERV, and thus continue the many important benefits NSCC brings to the mutual fund marketplace as set forth above.

The Commission recognizes in the proposing release that the proposed rule change, if adopted, will require substantial changes in the way intermediaries process mutual fund orders, and will necessarily disadvantage certain transactions effected through certain intermediaries. In this letter, NSCC addresses such processing changes and disadvantaged transactions as they relate to transactions which are currently processed through Fund/SERV.

NSCC currently processes mutual fund orders over a 22-hour period each business day. Most orders are received and transmitted in batch files with NSCC running 29 batch cycles in each 22-hour day. Approximately 27% of the total daily orders are received by NSCC between 8:00 a.m. and 4:00 p.m. The other 73% are received outside of these hours, after they have been reviewed by the intermediary (e.g., a bank, broker-dealer or 401(k) plan administrator) and processed through their internal systems prior to transmission to NSCC. Intermediaries will necessarily have to change their processing flows significantly, and some may have to impose an earlier cut-off time on receipt of orders from their customers, in order to transmit all such orders to NSCC by 4:00 p.m.

In addition, certain transactions such as portfolio rebalancing transactions (explained below) are currently calculated and processed at the intermediary based on the current day's price, and subsequently transmitted through Fund/SERV in post-4:00 p.m. files. For several reasons, it is impossible to complete processing and transmission of certain of these transactions as completed orders prior to 4:00 p.m. Upon the implementation of the proposed amendments, therefore, these transactions will no longer be eligible to receive same-day pricing.

Comments on the Alternative Proposal

The Commission included in the proposing release a request for comments on an alternative proposal designed to prevent the manipulative late trading of mutual fund shares. Under this alternative, fund intermediaries (including, NSCC assumes, certain fund intermediaries which are not registered with or supervised by the Commission) would be required to adopt certain safeguards against late trading in order to be eligible to submit orders to designated transfer agents or clearing agencies after 4:00 p.m. These measures would include, for example, electronic or physical time-stamping of mutual fund orders by fund intermediaries in a manner that could not be altered or discarded once the mutual fund order is entered into the trading system.

Were the Commission to adopt the alternative proposal, NSCC would be prepared to work with the Commission and the industry to adopt appropriate safeguards in its Fund/SERV system in order to facilitate proper pricing with respect to mutual fund orders, such as enhanced electronic audit trails for mutual fund orders.

NSCC believes that, if the Commission adopts the alternative proposal, it should include all types of fund intermediaries that currently process after 4:00 p.m., in order to preserve the efficiencies of the current processing systems.

Implementation of Proposed Rule by NSCC

Establishing Time of Receipt

If the proposed rule is adopted, NSCC would establish a uniform methodology for determining when a mutual fund order would be deemed to be received by NSCC (i.e., as a technical matter, at what point during NSCC's automated processing a mutual fund order would be electronically time-stamped as received), based upon the earliest point of receipt at which the order is not susceptible to alteration by its sender.

As indicated above, most participants submit orders to NSCC in transmissions of batch files which contain multiple orders. NSCC anticipates that it would time stamp each file upon completion of a transmission, and subsequently include the time stamp from the file on each order within the file. Each order which is subsequently transmitted to the fund by NSCC would therefore bear the time stamp indicating the time that the order was received by NSCC.

As recognized in the proposing release, NSCC would have additional time after the time-stamping of the mutual fund orders to complete the processing of orders that were received earlier in the day, and such processing could be completed after the 4:00 p.m. close.7 NSCC believes that the distinction between the requirement to confirm receipt of a mutual fund order by 4:00 p.m. (for purposes of the forward pricing requirement of the proposed rule) and the ability of NSCC to process such mutual fund order after 4:00 p.m. (for purposes of the prompt and orderly clearance and settlement of the order) is critical to NSCC's ability to accommodate a 4:00 p.m. close without undue disruption to the market place. Completion of order processing by 4:00 p.m. at NSCC would require substantially increased computer system capacity and would require NSCC to establish a significantly earlier cut-off time for receipt by NSCC. Imposition of an earlier cut-off time at NSCC could further impact the ability of firms using Fund/SERV to offer same-day pricing to their customers.

The Definition of "Order": Subsequent Provision of Ancillary Information

The term "order" is defined in the proposed rule as "a direction to purchase or redeem a specific number of fund shares or an indeterminate number of fund shares at a specific value."8 An "order" for mutual fund shares would be complete for purposes of the forward pricing requirement when it contains a specified fund security, and a specific number of shares or a specific dollar value. An order would be deemed irrevocable as of the next pricing time after it is received by the mutual fund, its designated transfer agent or a registered clearing agency.

NSCC would, therefore, deem a communication to be an order for purposes of establishing time of receipt if the communication contained a mutual fund security identifier, and identified a specific number of shares or a dollar amount subject to a purchase or redemption.

Intermediaries currently review and process orders in their internal systems to calculate or determine other elements of the trade. For example, calculation of the appropriate front-end load sales discount ("breakpoint") to which an investor is entitled may be based upon the rights of accumulation, letter of intent or other applicable fund rules. An intermediary's submission after the 4:00 p.m. close of this ancillary order information for a previously submitted order would seem to be consistent with the proposed rule.

Accordingly, NSCC suggests that the Commission include language in the release accompanying the final version of the rule indicating that fund intermediaries may supplement mutual fund orders with certain ancillary information after receipt of the order by a mutual fund, its designated transfer agent or a registered clearing agency, provided that the ancillary information would not have the effect of canceling a mutual fund order or modifying the identity of the fund or the number of shares or the dollar value contained in the order after the time that the fund has established for calculating net asset value.

Exchange Transactions

The definition of "order" in the proposed rule accommodates exchange transactions, by defining an order to include the purchase of an unspecified number or value of shares of a fund "...using the proceeds of a contemporaneous order to redeem a specific number of shares of another fund (or exchange)..." Currently, NSCC supports a transaction type which accommodates exchanges within a fund family at the current day's price. NSCC anticipates that it would expand this transaction type to identify exchanges between or among funds in different fund families, for purposes of allowing the fund on the purchase side of the exchange transaction to identify the purchase order as "linked" to the redemption side, and hence entitled to same-day pricing under the proposed rule. NSCC could also expand its exchange transaction type to identify a mutual fund purchase order processed through Fund/SERV as linked to a contemporaneous redemption order of an investment which is not a mutual fund or otherwise not processed through NSCC's Fund/SERV system. This would allow the fund on the purchase side of the exchange to recognize the purchase order as the subject of an exchange which is entitled to same-day pricing under the proposed rule.9

Portfolio Rebalancing Transactions

In a portfolio rebalance transaction, an investor instructs that his or her holdings be reallocated among multiple investment options according to the total value of the portfolio, allocating a percentage of the total value to each investment option. A portfolio rebalance transaction requires complex calculations based on net asset values prior to establishing what action needs to be taken (i.e., whether any specific investment option will be the subject of a purchase or a redemption order).

NSCC notes that it is not possible for NSCC to build a functionality that could translate portfolio rebalancing transactions into orders eligible for same day pricing under the proposed rule, due to the very large number of unknown variables attendant to a rebalancing order and the nature of the information that is required to effect an investor's rebalancing instruction10.

Preliminary Estimates of Required Time and Costs Associated with System Changes Necessary to Accommodate the Commission's Proposal

NSCC would need to make significant changes to a number of its mutual funds software applications to implement the relevant provisions of the final rule. NSCC would also need to amend its Rules & Procedures to reflect these changes, and the changes to NSCC's Rules & Procedures would have to be filed with and approved by the Commission pursuant to Section 19(b) of the Exchange Act.

Changes to NSCC's mutual fund applications would include:

  • time-stamping transmissions at the earliest processing point and applying the time-stamping of the transmission to each order within a transmission;

  • making all of the essential elements in an order mandatory fields;

  • building a functionality for the communication of ancillary information, related to a specific order; and

  • expanding the exchange transaction functionality to identify exchanges between unrelated fund families or for which the mutual fund purchase order relates to proceeds from a sale transaction outside of NSCC.

NSCC participants would be required to make corresponding changes in their computer systems, and some may decide to change to "real-time" transmissions or to transmit files to NSCC using increased bandwidth in order to allow them to transmit larger volumes of data to NSCC shortly before the 4:00 p.m. close.

Due to the magnitude of the changes, NSCC would require a substantial period to design, program and test its systems changes both internally and with its participants. NSCC would also plan to run the revised system in production mode prior to the effectiveness of the final regulations. This would allow NSCC's members to assess whether their transmission procedures with NSCC would be sufficient to permit them to meet the 4:00 p.m. close while still conforming with their service commitments to their customers.

Due to the magnitude of the change in general, the exact extent of the software application changes required cannot be assessed until a final rule is adopted. Further, changes in the behaviors of NSCC's participants in light of the parameters of the final rule may require additional modifications later on. NSCC has worked closely with the industry over the last few months to prepare a preliminary assessment of the changes that would likely be required under the parameters of the rule as currently proposed. NSCC would continue to work closely with the Commission and the industry while modifying its systems to accommodate the parameters of the final rule.

Based on its preliminary assessments, NSCC believes that its system can be modified to accommodate the requirements of the proposed rule within the suggested one-year transition period, and that the full one-year transition period is necessary in light of the nature and extent of the changes that will be required and the need for careful and extensive testing of those changes. NSCC requests, however, that it be permitted to consult with the Commission after adoption of a final rule and throughout the transition period, with the possibility of requesting an extension or phased implementation schedule should unforeseen circumstances occur.

We note, also, that if additional, unrelated changes are required in respect of mutual fund processing, this could further impact the time required by NSCC and its members to implement these changes. We are aware that the Commission has other initiatives underway in respect of the consideration of rules to help prevent market timing and in respect of omnibus trading. It is not possible at this time to factor in any additional software or processing changes that may be required as a result of those initiatives, nor how the timeframe for implementation permitted by the Commission in those instances could impact completion of the processing changes required to implement this proposed rule.

NSCC notes that it is difficult to estimate with any certainty at this point its costs for modifying its systems to facilitate a 4:00 p.m. close, for the reasons stated above. Based on its preliminary assessment and subject to this caveat, NSCC estimates that its costs for making the necessary system changes could be in excess of $5 million. In addition, participants will incur their own costs in adopting corresponding changes to their systems, as required.

Because NSCC is operated as a not-for-profit industry utility, its costs are passed on to its users. In this case, we anticipate that the costs of these changes would be borne by the fund intermediaries and funds which use Fund/SERV and NSCC's other mutual fund services.

Recommendations Regarding the Emergency Exception

The proposed rule would provide an exception from the forward pricing requirement if there were an emergency that would prevent a designated transfer agent or a registered clearing agency from receiving mutual fund orders by 4:00 p.m. The chief executive officer ("CEO") of the designated transfer agent or the registered clearing agency would have to notify the mutual fund of such emergency. The preamble of the proposing release indicates that the emergency exception is intended to cover situations that are external to a broker-dealer, designated transfer agent or registered clearing agency, such as a power failure, hurricane or other natural disaster.11

NSCC would like to offer two recommendations with respect to the proposed emergency exception.

First, NSCC believes that, given that NSCC processes transactions with over 600 mutual funds, it clearly would be impractical for its CEO to provide notice to each of these mutual funds in the case of an emergency, and that the CEO may not be available at the time that the notice must be given. Accordingly, NSCC recommends that the Commission include language in the final version of the proposed rule that would permit the CEO of a designated transfer agent or a registered clearing agency to designate one or more other individuals to assume the CEO's obligations under the emergency exception to the forward pricing requirement. In addition, given the number of funds with which NSCC interacts, NSCC recommends that the language in the final rule give a registered clearing agency discretion in the method in which it communicates the notice to the fund (e.g., system broadcast, e-mail or other method of communication reasonably capable of receipt by the fund).

Second, NSCC believes that the circumstances contemplated in the preamble of the proposing release that would constitute an emergency are too narrow in the case of a registered clearing agency. NSCC believes that this exception should include significant system outages and delays that may impact the clearing agency's orderly receipt and time-stamping of mutual fund orders by the 4:00 p.m. close, perhaps by reference to the sorts of significant outages and delays that a clearing agency is required to report to the Commission under the Commission's Automation Review Policy ("ARP").

Outages and delays in a clearing agency system cannot reasonably be anticipated by market participants and thus do not present a realistic opportunity for manipulative late trading. Such outages or delays would be attributable to circumstances beyond the control of any market participant and unrelated to any fraudulent trading activity. Nonetheless, such outages or delays would have the same effect on mutual fund orders as the sort of external occurrences described by the Commission in the proposing release and, given the large number of mutual fund orders that are communicated through Fund/SERV, could significantly disrupt the mutual fund marketplace.

Accordingly, NSCC recommends that the Commission indicate, in the release accompanying the final version of the proposed rule, that the emergency exception could also be invoked in the event of a significant systems outage or delay that prevents a registered clearing agency from timely receiving orders, with respect to which the registered clearing agency submits to the Commission a Systems Outage Notification pursuant to the Commission's Automation Review Policy, and the registered clearing agency's chief executive officer or designee notifies the fund of such systems outage or delay.

The Commission may also wish to consider whether a similar provision should be available, upon appropriate notice to the fund, to transfer agents and to intermediaries submitting mutual fund orders.

* * *

NSCC appreciates the opportunity to comment on the proposing release. Please feel free to contact Ann E. Bergin, Managing Director of NSCC at 212-855-5655, or Carol A. Jameson, Senior Counsel and Vice President of NSCC at 212-855-3213, with any questions that the Commission staff may have regarding the above comments.

Sincerely yours,


By: /s/ Carol A. Jameson

Carol A. Jameson
Vice President and Senior Counsel

NSCC Comment Letter on Late Trading 2-6-04

1 Investment Company Act Release No. 26288 (December 11, 2003), 68 Fed. Reg. 70388 (December 17, 2003) (the "proposing release").
2 Fund/SERV is a registered trademark of The Depository Trust & Clearing Corporation.
3 Use of Fund/SERV is limited to NSCC members, which are typically broker-dealers, banks, third-party administrators, mutual funds, advisors and distributors of mutual funds. Mutual funds and their distributors may (and typically do) direct receipt of orders from NSCC to their transfer agents. Qualification for NSCC membership is set forth in NSCC's Rules, which are available on NSCC's website: As a self-regulatory organization within the meaning of the Exchange Act, NSCC's rules of operation are subject to approval by the Commission (see 15 U.S.C. 78c(a)(26), 78(s)(b)).
4 NSCC is a wholly-owned subsidiary of The Depository Trust & Clearing Corporation, which in turn, is owned by its principal users -- major banks, broker-dealers, mutual fund firms and other companies within the financial services industry. DTCC's Board of Directors is made up of 21 directors who also serve as directors of NSCC.
5 Although some funds use a different time for establishing net asset value, we assume for purposes of this letter that the funds price at 4:00 p.m. and hence will establish 4:00 p.m. receipt as the "close" or "cut-off" time for an order to be assigned that day's price. For funds which price at a different time during the day, that particular time of the day would be the relevant time of receipt for these purposes.
6 NSCC notes that being designated as an authorized time-stamping organization would be consistent with NSCC's obligations under the Exchange Act to facilitate the prompt and accurate clearance and settlement of securities transactions and to protect investors and the public interest. See Exchange Act § 17A(b)(3)(F), 15 U.S.C. § 78q-1(b)(3)(F).
7 See proposing release, 68 Fed. Reg. at 70391 n.28.
8 See proposing release, 68 Fed. Reg. at 70398. NSCC believes that it is implicit in this definition that the fund securities that are the subject of the order also be identified.
9 This assumes the final rule permits mutual fund purchase orders resulting from an exchange transaction to receive same-day pricing when the proceeds are derived from the redemption or sale of a non-mutual fund investment.
10 For example, a rebalance order from an investor in a retirement plan which contained twelve investment choices could result in 132 possible mutual fund (or other investment) orders, any one of which could be an order to purchase or an order to redeem, depending upon that day's net asset values. In addition, some of the investment options may not be processed through NSCC's Fund/SERV system. Today, the retirement plan administrator processes the rebalance transaction data through its system, based on knowledge of the applicable plan rules and information specific to the identity of the investor, after current day fund prices have been established. The administrator then calculates the orders that have resulted from the rebalance instructions. It sends the net amount of the resultant mutual fund orders through NSCC for communication to the applicable funds, and routes order data that is not processed at NSCC to other systems. An analogous process is used by broker-dealers and other intermediaries when processing portfolio rebalancing instructions for retail investors. We are advised that some retail firms rebalance portfolios based on the previous day's net asset values of the various investments, but that same-day pricing is typically applied to an investor's rebalancing or reallocation instruction in a retirement plan.
11 See proposing release at 70391 n.36.