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PROFIT SHARING / 401k COUNCIL OF AMERICA COMMENTS ON SECURITIES AND EXCHANGE COMMISSION PROPOSED RULE ON AMENDMENTS TO RULES GOVERNING PRICING OF MUTUAL FUND SHARES
File number S7-27-03
January 23, 2004
Jonathan G. Katz
Securities and Exchange Commission
- The ability to enjoy same day pricing when conducting transactions is highly valued and important to retirement plan participants even though, like all investors, they understand the value of long term investing and very rarely transfer their funds.
- The proposed rule will hinder competition, efficiency, and capital formation. It will influence employers to adopt a specific service provider arrangement and place a large segment of the retirement planning industry at a disadvantage. It could also result in a bias by participants to invest in the proprietary funds of the service provider when also offered funds from other fund complexes.
- A single clearing agency, if viable, would likely provide the best assurance that no late trading is occurring, but only if all trades, including direct trades with a fund, are processed through the system. However, it is not clear if such a system is technically possible. The clearing house approach is certain to result in additional costs for investors and it will likely substantially limit the ability of retirement plan participants to enjoy same day pricing.
- The Commission explains the disparate treatment of some plan intermediaries by noting that they are not subject to regular examination by the Commission or subject to a new rule requiring that all funds have policies and procedures in place designed to prevent late trading. This revelation by the Commission is very helpful because it defines the problem for other plan intermediaries as one of regulatory oversight, not technological barriers.
- PSCA suggests that it is appropriate to require all intermediaries engaged in the late processing of fund orders to agree to the Commission's jurisdiction for the narrow purpose of insuring that no late trading abuse is occurring. Technology exists today to assure that trades are made in compliance with rules the Commission may issue under this approach.
The Profit Sharing/401(k) Council of America (PSCA) is a non-profit national association of employers who sponsor defined contribution retirement plans for their workers. For over fifty-five years, PSCA has identified and shared best practices with its members, represented their interests in Washington, and provided analysis and reportage on the latest regulatory changes. PSCA members range in size from very small independent businesses to firms with hundreds of thousands of employees. Our members believe that profit sharing, 401(k), and related savings and incentive programs strengthen the free-enterprise system, empower and motivate the workforce, improve domestic and international competitiveness, and provide a vital source of retirement income.
PSCA commends the Commission for its quick response to the recent allegations and settlements in which market timing and late trading violations occurred by issuing this and other proposed and final rules. Transparency and trust are important cornerstones of the defined contribution system on which approximately 70 million American workers rely for their retirement security, including over 42 million 401(k) plan participants. The employer provided defined contribution system, working in partnership with the government and financial institutions and other service providers, is responsible for the "ownership society" that has transformed rank and file American workers into owners of capital with a real stake in the economic success of this country. PSCA is committed, as is the Commission, to restoring trust between these largely unsophisticated investors and the mutual fund system. For this to occur, it is essential that a new rule on fund pricing recognize the important role that employer provided retirement plans play in making investment opportunities available to average Americans.
Understanding the employer provided retirement plan system.
Mutual fund investments are included in the vast majority of employer provided defined contribution plans. According to the Investment Company Institute, one third of all mutual fund assets are held in retirement accounts. Employers who sponsor retirement plans for their workers are subject to oversight by the Departments of Treasury and Labor. The Employee Retirement Income Security Act (ERISA) imposes a fiduciary duty on employers when discharging their duties with respect to a plan. Fiduciaries must operate the plan "solely in the interest of the participants and beneficiaries and for the exclusive purpose of providing benefits to participants and their beneficiaries." This duty applies to the selection of fund investments and to spending plan assets for services related to the operation of the plan. Plan services include recordkeepers and other intermediaries that implement the specific instructions of participants and beneficiaries regarding contributions, distributions, loans, and, for participant-directed plans, investment choices. Individual recordkeepers may or may not process fund orders. Most recordkeepers delegate investment transaction processing to another plan intermediary. While there are thousands of recordkeepers, there are significantly fewer entities involved in actually processing financial transactions with a fund or other investment entity. Some recordkeepers are also fund management companies. Sometimes this fund management company, in addition to recordkeeping, also processes plan trades. According to PSCA's annual survey of profit sharing and 401(k) plans reflecting 2002 plan year experience, 12.6 percent of plan participants are in bundled plans where the service provider is a mutual fund management company. Under this "bundled provider arrangement," the plan's investments usually include funds managed by the same company providing the recordkeeping and trading services. In some instances, the funds managed by the recordkeeper are the only investments included in the plan. As discussed below, the bundled provider arrangement involving a mutual fund management company may enjoy a competitive advantage under the proposed rule, and participants in plans with other arrangements, (87.4 percent of participants) will be disadvantaged.
Regardless of the service provider arrangement, processing retirement plan investment instructions is a complex and time consuming process that requires insuring that a myriad of laws and the plan's unique design specifications are complied with before a trade is forwarded to a fund. For example, one prerequisite under the existing system is the release of the net asset value (NAV) before an order can be finalized. NAV's are released well after a fund's closing time. As the proposed rule's background section states, trades that are received by an intermediary before a fund closing time are not forwarded to the fund until "the middle of the night."
Same day pricing is important to all investors.
PSCA's 2002 plan year survey reflects that 79.6 percent of participant-directed plans offer same day pricing. While the overwhelming majority of plan participants, like all investors, understand the value of long term investing and very rarely transfer their funds, the ability to enjoy same day pricing when conducting transactions is highly valued and important when making investment decisions. This is especially true for large transactions taken in anticipation of retirement. For example, an investor preparing to purchase an immediate annuity would be wise to transfer assets into a cash equivalent investment prior to initiating the annuity purchase in order to lock in the amount available for annuitization. Without same day pricing, an intervening major economic event could significantly reduce the assets available to purchase an annuity, reducing lifetime income for the participant and perhaps his or her spouse. While same day pricing cannot prevent unexpected economic events, it does enable an individual to implement or change financial decisions with complete and current information. PSCA does not believe that retirement plan participants are less sensitive to the advantages of same day pricing than investors who purchase fund shares by other avenues. The Commission should avoid solutions that harm retirement plan participants based on this false assumption. Rather, a level playing field solution should be sought for all investors.
The proposed rule creates winners and losers among participants and plan service providers.
In order to offer same day pricing, the proposed amendments would require that an order be received by the fund, its designated transfer agent, or a registered securities clearing agency by the fund's closing time, generally 4 p.m. Eastern Time. The ability to offer same day pricing to plan participants will be determined by the selection of plan intermediaries and plan investments. If a plan's intermediary is affiliated with a fund management company, the intermediary is designated by the fund as its designated transfer agent, and plan investments are made in funds managed by the same company, the proposed amendment will not disrupt the ability to offer same day pricing to participants. Any other arrangement that provides for same day pricing will require the use of the clearing agency, an alternative that is less attractive from both a cost and time perspective. The effect will be to influence employers to adopt the bundled service provider arrangement and place a large segment of the retirement planning industry at a disadvantage. It will also result in a bias by participants to invest in the proprietary funds of the intermediary when also offered funds from other fund complexes if the proprietary funds offer better same day pricing privileges, a condition which this proposed rule would promote.
The proposed rule will hinder competition, efficiency, and capital formation.
Section 23(a)(2) of the Exchange Act requires the Commission to consider the anti-competitive effects of any rules that it adopts under the Exchange Act. In addition, Section 23(a)(2) prohibits the Commission from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. Section 2(b) of the Securities Act, Section 3(f) of the Exchange Act and Section 2(c) of the Investment Company Act require the Commission, when engaging in rulemaking, to consider or determine whether an action is necessary or appropriate in the public interest, and consider whether the action will promote efficiency, competition, and capital formation. As noted above, the proposed rule will create advantages for certain plan service providers and funds.
The Commission properly notes that in order to enjoy same day pricing, third-party intermediaries will have to place their orders earlier in the day than investors who conduct business directly with the fund's designated transfer agent. This creates a competitive disadvantage for third-party intermediaries. Funds that are not affiliated with retirement plan intermediaries will be less attractive to retirement plan participants because they will be disadvantaged in offering same day pricing. Many plan participants will make less efficient investment decisions because they will no longer have current price information when they make investment decisions. Of course, the proposed rule, to the extent it prevents late trading, will benefit capital markets. A cost-benefit analysis is required. However, as we discuss later, the Commission can achieve its goal without harming competition, efficiency, or capital formation by adopting a different approach.
The registered securities clearing agency.
PSCA is intimately involved in efforts to examine the viability of a clearinghouse system to permit late processing of properly placed trades. A single clearing agency, if viable, would likely provide the best assurance that no late trading is occurring, but only if all trades, including direct trades with a fund, are processed through the system. However, it is not clear if such a system is technically possible. The clearing house approach is certain to result in additional costs for investors and it will likely substantially limit the ability of retirement plan participants to enjoy same day pricing. The clearing agency will have to account for trades involving investments currently not within its scope. Unless the proposed rule is amended to eliminate the option for funds to receive orders directly, the previously discussed issues of competitiveness and efficiency will remain unresolved because of cost and time-lag disadvantages related to dealing with a clearing agency. As discussed, retirement plans are limited in their ability to enjoy the former option and it may not be prudent public policy to encourage such behavior. While the clearinghouse approach, if modified to include direct mutual fund transactions, has its merits; PSCA believes that a better method exists to address the late trading problem.
Treatment of funds and registered separate accounts.
PSCA notes with interest the treatment of funds and certain conduit and registered insurance company separate accounts in the proposed rule. Receipt of an order by these entities by the fund closing time will satisfy the new requirements despite, as the proposed rule notes, "fund managers themselves have permitted late trading by favored investors." These entities will undoubtedly continue to process trades long after the fund's closing time, as permitted under the proposed rule. Apparently, the Commission is confident that representations by these entities that all the trades were received by closing time (and not tampered with thereafter) can be relied upon. These entities use technology common to all plan intermediaries. In fact, these entities frequently act as intermediaries for other funds, and would have to comply with the clearinghouse method to enjoy same day pricing when acting in that capacity. The Commission explains this disparate treatment by noting that other fund intermediaries are not subject to regular examination by the Commission or subject to a new rule requiring that all funds have policies and procedures in place designed to prevent late trading. This revelation by the Commission is very helpful. It defines the problem for other plan intermediaries as one of regulatory oversight, not technological barriers.
Recommendation for third party fund intermediaries.
As the Commission knows, according to the Investment Company Institute, 85 to 90 percent of all fund trades are placed through intermediaries. PSCA commends the Commission for seeking comments on an approach that would allow fund intermediaries to submit orders to a designated transfer agent or clearing agency after closing time if certain verifiable procedures are implemented to prevent late trading. These procedures include tamper proof time stamping, certification policies, and independent audits. PSCA recommends implementation of such a system by the Commission. We are confident that technology exists today to assure that trades are made in compliance with rules the Commission may issue under this approach.
The Commission legitimately questions how it would police compliance by fund intermediaries over which it currently has no regulatory authority. PSCA suggests that it is appropriate to require all intermediaries operating under this approach (and not already subject to the Commission's jurisdiction) to agree to the Commission's jurisdiction for the narrow purpose of insuring that no late trading abuse is occurring. Proposed legislation, HR 2420 and S 1971, includes PSCA-supported provisions that take this approach. The agreement to Commission jurisdiction should be limited to the relatively small group of entities that collect, process, and forward trades to funds or a clearing agency and not to the much larger group of plan recordkeepers that may not be involved in any trading activity. When exerting jurisdiction, the Commission should strive to apply the same oversight and requirements that apply to investment companies with respect to preventing late trading abuse. PSCA is prepared to assist the Commission in the formulation of procedures necessary to achieve this important goal.
While undoubtedly well intentioned, the proposed rule is problematic. It creates a bias unrelated to investment performance favoring bundled providers that could result in higher prices that are often paid by investors. Investor returns could be further diminished by bias against higher yielding nonbundled investments. Plan sponsors face additional fiduciary scrutiny for failing to properly evaluate or select higher yielding unbundled investments. By adopting PSCA's recommendation, the Commission can address its concerns about not being able to insure compliance by third party intermediaries not presently regulated by the Commission. Competitiveness issues will disappear because all entities will be free to decide to offer same day pricing if they wish. Employers will be able to structure their employee retirement plans without concern about impacting the ability to offer same day pricing. Cost increases will be minimized. Most importantly, many more investors will be free to enjoy the advantages of same day pricing.
Thank you for this opportunity to comment. Please feel free to contact me at 312 441 8550 or Edward Ferrigno at 202 626 3634 if you have any questions or if we can be of any assistance.
David L. Wray