SUNGARD DATA SYSTEMS INC.
680 E. Swedesford Road
Wayne, Pennsylvania 19087
February 6, 2004
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. S7-27-03
Amendments to Rules Governing Pricing of Mutual Fund Shares
Dear Mr. Katz:
SunGard Data Systems Inc. ("SunGard") provides integrated IT solutions to a wide range of financial institutions, including retirement plans and their record keepers, banks, trust companies, insurance companies, investment managers, brokers, transfer agents and investment companies. We provide software, systems and support services to over 20,000 customers, including 50 of the world's largest financial services companies, with over $15 trillion in investment assets worldwide accounted for and managed daily on SunGard systems. We support interested parties throughout all phases of securities transactions, from order entry through final settlement, and enable our customers to efficiently process such transactions via our network of integrated systems. As a result, approximately five million trades are processed by financial intermediaries daily via SunGard systems.
This letter is written in response to the SEC's request for comment on the proposed amendments to Rule 22c-1 under the Investment Company Act of 1940, as amended ("Rule 22c-1"), as set forth in SEC Release No. IC-26288 (the "Release"). The proposed amendments would effectively repeal the SEC's current position with respect to Rule 22c-1 and mandate a much narrower interpretation of the Rule. Today, an order regarding mutual fund shares receives the current day's price if the fund, any authorized designee of the fund, or an authorized designee of the fund's designee receives the order by the time that the fund calculates its net asset value for the day ("NAV").1 Following enactment of the proposed amendments, an order would receive the current day's price only if the fund, its designated transfer agent or a registered clearing agency (i.e., the NSCC) receives the order by the time the fund's NAV is calculated. As a result, many of our customers will be faced with the daunting task of essentially "un-developing" the enhancements to software, processes and procedures implemented during the past decade in order to accommodate a hard close for order input several hours earlier than the customary fund cut-off of 4:00 pm EST. While all market participants would agree that meaningful reform and enforcement is necessary to curtail illegal late trading and harmful market timing of mutual funds, we believe that such a dramatic modification of current SEC policy would severely inhibit valuable technological development and thereby further disadvantage the very investors adversely impacted by the recent trading abuses.
In consideration of the concerns expressed to us by our customers, we are particularly apprehensive about the impact the proposed amendments will have on retirement plans and their participants. Specifically, we suspect that the proposed rule will undo the progress made by plans in achieving investor parity for their participants relative to other market participants. As a technology provider, we strongly encourage the SEC to investigate a solution that takes advantage of technological innovation as a means of ensuring a level playing field for all market participants.
In this regard, given our relatively unique perspective as a service provider to interested parties on both sides of mutual fund transactions, we would like to offer our support for the alternative approach described in the Release as a means of curtailing abusive trading practices within the mutual fund industry.2 While it is clear that current controls are not adequate to prevent abuse by unscrupulous financial intermediaries, we firmly believe that technology exists, or may be developed within a reasonable timeframe, that would provide adequate controls as well as a sufficient audit trail to facilitate enforcement with little, if any, adverse impact on the investor.
PROPOSED AMENDMENTS TO RULE 22c-1
Over the past decade, retirement plan participants have continually pressured plan sponsors and administrators for access to a real-time trading environment. A decade ago, virtually all plans were valued on a monthly basis. In contrast, according to the Profit Sharing/401k Council of America, in 2002, nearly 80% of participant-directed plans offered daily valuations. This trend continues as many plans are now providing self-directed account options that provide participants with real-time market interaction in response to requests by the retirement plan participants themselves. As a result, the accessibility to such types of access is now a key selection criterion for plan sponsors choosing a record keeping service provider. Therefore, despite the widespread belief that most fund investors are not sensitive to the time at which their orders are priced, parity with other market participants is extremely important to retirement plan participants.
In 1997, Charles Schwab & Co., Inc. ("Schwab") submitted a no-action request to the SEC.3 Generally, Schwab requested that the SEC clarify whether a mutual fund could, in compliance with Rule 22c-1, price a mutual fund order based on the fund's NAV next computed after the order is placed with a third party, even when the order is not actually transmitted to the fund until after the computation of NAV for that day. In concurring with Schwab's position that orders placed with a financial intermediary or such intermediary's sub-designees may be deemed to have been received by a fund for purposes of Rule 22c-1 at the time that such intermediary or such sub-designee received the order, the staff relied on various representations made by Schwab regarding the safeguards and controls which Schwab would implement to prevent potential abuse. The staff also suggested that each fund's board of directors should consider the adequacy of such controls in ratifying and periodically reviewing agreements with Schwab and other similar financial intermediaries.
As you are well aware, in reliance on the SEC's stated position as set forth in the 1997 No-Action Letter, industry participants now price mutual fund orders at the NAV next computed after receipt of such order by the fund, by an authorized designee of the fund or by an authorized designee of the fund's designee, even if the order is actually submitted to the fund's transfer agent at a later time. Immediately following the publication of the 1997 No-Action Letter, there was movement within the mutual fund industry to adopt the safeguards and controls suggested in the letter. However, in conjunction with the recent revelations regarding illegal late day trading came the realization that such safeguards and controls had not been maintained or enforced on a consistent basis throughout the industry. Thus, whether the safeguards and controls described in the 1997 No-Action Letter would be effective in curtailing illegal late trading and other potential abuses has not been sufficiently tested.
In lieu of enforcing the controls proposed by the 1997 No-Action Letter, the amendments to Rule 22c-1, as proposed in the Release, would effectively repeal the SEC's existing position and, instead, impose a strict interpretation of Rule 22c-1 pursuant to which receipt by the fund would be deemed to include only receipt by the fund itself, the fund's one designated transfer agent or the NSCC. To effectively implement such an abrupt change in position would require reprogramming of software and systems, ranging from voice response systems to retirement plan participant record keeping systems to the shareholder record keeping and processing systems employed by funds, transfer agents and the NSCC in order to accommodate the proposed hard close for delivery and receipt of mutual fund orders. Such reprogramming can be accomplished only after a considerable expenditure of time and money; time and money better spent on enhancing current technology and services.
Moreover, if the amendments are adopted as proposed, once again, the securities industry will be faced with a mutual fund marketplace in which plan participants are placed in an inferior position relative to other fund investors. Plan participants will be faced with next-day pricing, rather than the same-day pricing available to other fund investors, because of the need for plan record keepers to build sufficient processing time into the trading day. As a result, we believe the pressure from such participants to create investment parity will begin anew without any developmental support from the "time stamping organizations." Due to the small number of time stamping organizations identified in the Release and particularly in light of the fact that the NSCC is currently the only registered clearing agency, there would be no incentive for such organizations to invest in technology that would reestablish the current environment of investor parity between plan participants and other fund investors. More than likely, the cost of developing more efficient processing systems and bringing parity to the mutual fund marketplace will be borne, again, by the investors themselves who were not in any way involved in illegal late trading.
At the same time, we commend the staff's efforts in proposing a definition of "order" that contemplates the fact that a trade instruction may be committed prior to 4:00 P.M., while the specific details of the irrevocable trade may be provided to the fund after the NAV of the particular fund is available. This approach provides the flexibility necessary to accommodate mutual fund investing, while recognizing that the actual trade detail must be fully reconcilable with the original trade instruction in order to eliminate the manipulation of orders once a NAV is known. We hesitate, however, with respect to whether this definition would permit the rebalances and reallocations between and among funds that occurs daily in plan participant accounts. We note the special provision proposed by the staff to address the specific issue of exchanges, and suggest that perhaps an additional provision may be necessary to properly address rebalance and reallocation instructions, as well as instructions requiring compliance with ERISA prior to execution when such compliance requires knowledge of a fund's NAV, such as instructions involving loans or emergency withdrawals.
In lieu of amending Rule 22c-1 as proposed, we support the adoption of the alternative approach to eliminate late trading described in the Release.4 Essentially, the alternative approach would mandate the implementation of the safeguards and controls suggested by the 1997 No-Action Letter, while also mandating additional protections contingent on technological development. We believe this approach adequately protects investors from unscrupulous financial intermediaries, while retaining the investment parity among mutual fund investors that exists today.
As described in the Release, the alternative approach would not effect the SEC's current position regarding Rule 22c-1. However, in order for financial intermediaries (other than a fund's designated transfer agent or a registered clearing agency) to qualify as an "authorized designee" on behalf of a fund and be eligible to submit orders to a designated transfer agent or the NSCC's Fund/SERV after 4:00 pm EST, the financial intermediary must have adopted certain protections designed to prevent late trading. Consistent with the Release, at a minimum, such protections should include:
- Electronic or physical time-stamping of orders in a manner that cannot be altered or discarded once the order is placed. This safeguard is essential for creating an audit trail for enforcement purposes, but will require development dollars to implement in any meaningful way. We believe that many record keeping, portfolio management and trade processing systems have time-stamping capability today; the only issue for development is one of integrity. As in the equities marketplace, time-stamping could be required at each stage of the trade life cycle to ensure processing efficiency and integrity and a meaningful audit trail.
- Annual certification that the intermediary has policies and procedures in place designed to prevent late trades, and that no late trades were submitted to the fund or its designated transfer agent during the relevant period. Prior to the enactment of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"), this protection may have seemed of little consequence. However, post Sarbanes-Oxley, it is imperative that the signatory of such a certification have a reasonable basis for believing it to be correct. In order to provide such a reasonable basis, each intermediary would be forced to annually review, evaluate and potentially enhance the effectiveness of its procedures in detecting potential late day trading.
- Submission of the intermediary, or the intermediary's unaffiliated provider of the software or systems used by the intermediary in collecting orders, to an annual audit of its controls conducted by an independent public accountant or other qualified independent party who would submit his report to the fund's chief compliance officer. In light of the recent illegal late trading scandals, we agree that it is essential that an independent party review the system of controls implemented by the financial intermediary. As stated above, however, in contrast to the language describing this requirement set forth in the Release, we believe that this safeguard should contemplate an annual audit conducted by an independent third party that is not a public accountant but that is well-qualified to evaluate the integrity of software and systems, such as an independent consultant. In addition, consistent with H.R. 2420, an intermediary that utilizes software or systems supplied by an unaffiliated provider to collect orders should be permitted to rely on such provider's annual audit of the controls latent in such software and systems to satisfy this requirement. We offer this alternative in recognition of the fact that the cost of such audits may deter small intermediaries from continuing to compete in this environment, and also in recognition of the fact that most such providers already submit to such audits in the ordinary course of their business. In order to satisfy this audit requirement, however, we suggest that the submission to the fund's compliance officer by the financial intermediary of an unaffiliated provider's annual audit report include a certification that the intermediary utilizes the software or systems precisely in the manner contemplated by the provider's audit report. Such submissions could then be used by the relevant funds in considering or monitoring a designee's controls.
We also suggest that the following additional safeguards be imposed by the funds:
- Require specific authorization by the fund that late transmission privileges are to be extended for the benefit of a particular account serviced by the intermediary. No financial intermediary, despite such intermediary's qualification as an authorized designee of a fund, should extend or support late transmission privileges for the benefit of a particular mutual fund account without prior, specific authorization by the relevant fund on a per account basis. This control is intended to provide the fund with the opportunity to deny or limit such privileges with respect to a specifically identified mutual fund account, particularly an omnibus account, when the fund determines that it cannot adequately monitor the trading activity thereof. This control would not prevent the fund from authorizing the late transmission of orders generated on behalf of other mutual fund accounts serviced by the same authorized designee.
- Limitation of late transmission privileges on behalf of accounts comprised of qualified plan assets only. In conjunction with the control described in Paragraph A above, we can think of no justification for extending late transmission privileges beyond the retirement plan community. Given the nature of plan participant investment instructions and the complexity of aggregating and pricing orders at the individual and plan levels while complying with a rigorous regulatory overlay imposed by the Department of Labor, the need for processing time to produce valid trade detail following a fund's calculation of NAV is understandable. However, this same level of regulatory complexity does not exist for omnibus accounts generally, and although aggregation of orders is a critical component of omnibus trading, it is a component handled quite efficiently, within the confines of the trading day, in other securities markets.
We believe that this alternative approach will effectively curtail illegal trading and abusive market timing in the mutual fund industry while, at the same time, maintaining investor parity and providing appropriate incentives to entice financial intermediaries to enhance the quality and integrity of the software and systems that support mutual fund trading today.
In conclusion, it is our belief that restricting "time-stamping organizations" solely to the fund company, a single designated transfer agent, and a registered clearing agency (currently, only the NSCC) is too limiting. Without sufficient competition, there is no incentive for any of these entities to develop a sophisticated technological solution to prevent late day trading and market timing in the mutual fund industry while, at the same time, promoting efficiency for the benefit of market participants. We look forward to the possibility of working with the SEC and other industry participants in identifying such a technological solution that ensures a level playing field for all market participants.
Moreover, we applaud the SEC's efforts to quickly and effectively curtail trading abuses in the mutual fund industry, and sincerely appreciate this opportunity to comment on the SEC's recent proposal. We would welcome the opportunity to speak directly with the SEC staff regarding this submission or any of the recommendations discussed herein. For your convenience, our contact information is provided below. Thank you for your time and consideration.
SunGard Data Systems Inc.
By: Paul D. Schneider, CEO, SunGard Financial Networks
Ray T. Davis, CEO, SunGard Employee Benefit Systems
Donald D. Mackanos, President, SunGard Corbel
Kenneth J. Kempf, President, SunGard Investor Accounting Services
|1|| See, et. al., Charles Schwab & Co., SEC No-Action Letter (pub. avail. July 7, 1997); Investment Company Institute, SEC No-Action Letter (pub. avail. June 13, 1973); and Investment Company Act Release No. 5569 (Dec. 27, 1968).
|2|| See text accompanying Footnote 23 of the Release.
|3 || See Charles Schwab & Co., Inc., SEC No-Action Letter (pub. avail. July 7, 1997)(referred to hereafter as the "1997 No-Action Letter").
|4 || See text accompanying Footnote 23 of the Release.