February 6, 2004
Jonathan G. Katz
Re: File No. S7-27-03: Proposed Rule: Amendments to Rule Governing Pricing of Mutual Fund Shares
Dear Mr. Katz:
Thank you for the opportunity to submit comments on the amendments to Rule 22c-1 under the Investment Company Act of 1940 (the "Investment Company Act") governing the pricing of mutual fund shares recently proposed (the "Proposing Release") by the Securities and Exchange Commission (the "Commission"). Pursuant to the changes to Rule 22c-1 in the Proposing Release, to obtain the current day's price all purchase and redemption orders must be received by a fund, a single transfer agent designated by the fund (a "designated transfer agent"), or a registered clearing agency no later than the time at which the fund prices its securities. This arrangement, which is known as a "hard close" at 4:00 p.m., would significantly alter the long-standing provisions that permit suitable market intermediaries to accept customer orders until 4:00 p.m., then process and transfer those orders to the fund companies sometime after 4:00 p.m. (the so-called "soft close"), and still receive same-day pricing.
UBS Financial Services Inc. ("UBSFS") and UBS Global Asset Management (US) Inc. ("UBS Global AM") are affiliates of one of the largest integrated financial services companies in the United States. UBSFS, UBS Global AM and their affiliates include: (i) one of the nation's largest broker-dealers, which offers and sells approximately 3000 mutual funds representing over 150 fund families; (ii) a large transfer agent operation that services, among other things, the sale of mutual fund shares; (iii) a global asset management group that has approximately $434 billion in assets under management worldwide, including more than $58 billion in U.S. registered mutual fund assets; (iv) a large retirement account group; and (v) a full-service bank. Because of our extensive operations in all facets of the financial services industry that deal with mutual funds, and because we are directly affected by the Commission's proposal on both the intermediary side (through our broker-dealer) and on the fund company side (through our global asset management business group), we believe that we are well qualified to offer comments on the Commission's proposed amendments to Rule 22c-1.
Like the Commission, UBSFS and UBS Global AM are deeply concerned by recent events indicating that some market participants have engaged in late trading and market timing of fund shares. We agree with the Commission that significant steps must be taken to make certain that mutual fund investors' confidence in the industry is restored and that fund companies and their intermediaries are held to the highest ethical standards. The Commission is correct in pursuing an aggressive path to eliminate late trading and abusive market timing and implementing new safeguards surrounding the pricing of mutual fund shares.
We would differ with the Commission, however, in the precise solutions that have been proposed to address these issues. We believe that the Commission's hard close proposal is too drastic a measure to impose on the mutual fund industry. The 4:00 p.m. hard close will result in substantial costs, both to investors and to mutual fund intermediaries. Moreover, it is likely to result in a great deal of confusion among mutual fund investors in both retail and retirement accounts and to work to the detriment of certain classes of investors that we do not believe that the Commission intends to disadvantage.
UBSFS and UBS Global AM instead believe that additional significant protections should be added to the existing pricing procedures of Rule 22c-1. These safeguards would allow intermediaries, including broker-dealers, banks, and third-party administrators ("TPAs") for retirement accounts, to continue to accept trade orders until 4:00 p.m. and transmit those orders to the fund companies thereafter, while still obtaining same-day pricing for their customers. We note that this structure was proposed in legislation recently passed by the U.S. House of Representatives (H.R. 2420) (the "House Bill"). A companion measure has not yet been adopted by the U.S. Senate, although the Senate Banking, Housing, and Urban Affairs Committee is reviewing, through the hearing process, mutual fund industry practices. We discuss below both the disadvantages associated with a hard close at 4:00 p.m. and the additional protections that would be needed to ensure that a soft close continues to be viable.
For the past three decades, Rule 22c-1 has been interpreted by the Commission and by the industry in a manner that has promoted the sale of a maximum number of products in a free market to investors. The Commission staff has consistently taken the position during this period that under Rule 22c-1 orders can be considered "received" when they are received by intermediaries of the fund, including brokers and other agents. This interpretation has permitted "open architecture" - the ability of investors to purchase a multitude of mutual fund products from the same intermediary or from a wide variety of providers - to evolve in a manner that offers tremendous advantages to investors. Among other things, it has permitted both retail and retirement investors to obtain same-day investment and pricing and to enjoy certainty in exchanges among different fund groups. It also allows an investor to select a single trusted intermediary - a broker-dealer, investment adviser, etc. - from whom the investor can obtain integrated, consistent guidance and through whom the investor can purchase a wide range of products. These arrangements are commonplace today and allow the free flow of information and guidance. By encroaching on this open architecture, the Commission's proposed amendments to Rule 22c-1 would impose unnecessary restrictions on the ability of, and the manner in which, an investor may invest in mutual fund products. An unintended result of these barriers would be, among other things, an increase in the costs associated with mutual fund investment.
Because the Commission now doubts that its interpretation of Rule 22c-1, which permits intermediaries to process trades after 4:00 p.m., is sufficiently able to prevent late trading, it is now considering amending Rule 22c-1 to require that all purchase and redemption orders be received by the fund, its designated transfer agent, or a registered clearing agency no later than the time at which the fund prices its securities (e.g., 4:00 p.m.) to obtain the current day's price. As a result, fund intermediaries such as broker-dealers, banks, and TPAs of retirement plans, would have to submit orders to the fund well before 4:00 p.m. for their customers to receive the 4:00 p.m. price. Orders received later would receive the following day's price.
UBSFS and UBS Global AM believe that the "hard close" at 4:00 p.m. would impose costs on intermediaries and investors that are not justified by the benefits of the proposed amendments. The only benefit that we perceive will be derived by a hard close regime is greater certainty in policing late trading. While we would not minimize the importance of this goal, we also believe the Commission's proposed amendments would have significant adverse consequences for investors and market participants and would impose costs that could be reduced or eliminated by alternative approaches.
Below, we have tried to outline the costs associated with a 4:00 p.m. hard close. Following a discussion of the costs imposed by the proposed amendments, we discuss alternatives that we believe would be equally effective in deterring late trading while resulting in lower costs to the marketplace. These alternatives include substantial safeguards and protections designed to eliminate late trading.
Costs and Disadvantages Associated with the Commission's Proposed Amendments
Alternatives Other Than a "Hard Close" at 4:00 p.m.
UBSFS and UBS Global AM believe that the Commission, consistent with the goal of eliminating late trading, can still permit intermediaries to receive trade orders until 4:00 p.m. if adequate safeguards and protections are implemented. In the Proposing Release, the Commission offered an alternative arrangement for public comment that would allow intermediaries, with additional protections, to collect trade orders prior to 4:00 p.m. and transmit them to funds and their transfer agents after 4:00 p.m. We believe that this arrangement is in the best interests of investors and intermediaries because it would permit the elimination of late trading while avoiding the costs and disadvantages outlined above that would result from a "hard close" at 4:00 p.m.
We note that the House Bill is consistent with this alternative arrangement. The House Bill provides that trades collected by approved intermediaries (generally broker-dealers, retirement plan administrators, and other regulated entities) prior to 4:00 p.m. can be transmitted to the funds after 4:00 p.m., as long as such intermediaries are subject to: (1) procedures designed to prevent the acceptance of trades by such intermediaries after the time at which net asset value is calculated; and (2) an independent annual audit.
The Commission acknowledges a similar approach in the Proposing Release, which would be accompanied by additional safeguards. We discuss several of these protections in more detail below. With such safeguards in place, we believe that the Commission will have established an effective deterrent to late trading while significantly reducing the costs that would be imposed on mutual fund investors and market participants.
UBSFS and UBS Global AM would like to express their full support for the Commission's efforts to eliminate late trading and abusive market timing in mutual fund shares. We believe that it is vital to restoring investor confidence that all investors understand that a level playing field applies to all customers that decide to invest in mutual funds. The Commission's proposal to adopt a "hard close" at 4:00 p.m., however, would impose unnecessary costs and other burdens on investors and would create a system that discriminates against investors who need to avail themselves of the advice and guidance provided by intermediaries. We believe that the Commission can realize its goal of eliminating late trading in a less costly and intrusive manner by placing additional safeguards on existing arrangements that permit intermediaries as well as fund companies to accept trade orders until 4:00 p.m. and obtain same day pricing.
UBSFS and UBS Global AM thank the Commission for the opportunity to comment on the proposed amendments to Rule 22c-1, and we will continue to work with the Commission toward an effective resolution of these issues.
Very truly yours,