Speech by SEC Commissioner:
Statement before the Open Meeting regarding Mutual Fund Redemption Fees
Paul S. Atkins
U.S. Securities and Exchange Commission
March 3, 2005
Thank you, Mr. Chairman. Last March, I voted against a proposal to require funds to charge a 2% redemption fee. At the time, I explained that a mandatory rule effectively sanctioned the imposition of a tax on all fund investors. I was particularly concerned about taking such a step before we even had a sense about the magnitude of the market timing problem we were seeking to address. The proposed one-size-fits-all two percent redemption fee without any link to the actual costs incurred by funds only confirmed my suspicion that the fund industry would be the big winner at the expense of fund investors. The stated rationale for the proposal was that it embodied a balance between the need to maintain redeemability of fund shares and the need to make short-term shareholders absorb the costs of their rapid trading. The rule that we are adopting today seems better to embody this balance.
We received nearly 400 comments on the proposal. Approximately 85 percent of all commenters opposed the rule proposal, and investors who commented overwhelmingly opposed it. These investors worried that as a result of the shenanigans of a small class of highly sophisticated investors, sometimes with the complicity of fund management, the Commission was contemplating a rule, the burdens of which would be borne by average investors. One commenter compared instituting a mandatory redemption fee to "instituting a tax on mutual fund investors" and noted that "[t]he SEC has for 30 years led the way in lowering the costs of investing for investors and it would be a radical reversal in policy should the SEC vote to impose a mandatory redemption fee."1 Another commenter noted that: "These proposed rules would place additional hardship on small investors. They appear to be designed to further benefit the mutual fund companies by giving them even more fees."2 Commenters understood that while the fees may not go directly to the advisors, advisors certainly laugh all the way to the bank from the fees generated from bigger funds under management.
In light of my own concerns, which were echoed by investors, I am pleased that the staff, under the Chairman's leadership, has backed away from a mandatory redemption fee. The voluntary redemption fee that we are considering today is a great improvement. I should note that our explicit rejection of a mandatory rule signals that we are not encouraging or recommending that funds have redemption fees. This determination is appropriately made by fund boards. While I support the recommendation, I remain concerned about a number of aspects of this rule.
First, absent an express link to costs, it seems that the two percent cap could become the default level for redemption fees. Boards that determine that redemption fees are warranted must determine the level of such fees up to a cap of two percent. A fund's board should only impose a redemption fee if it determines that fund shareholders are being harmed by the absence of redemption fees, and any fee imposed should be designed to cover the costs of redemptions. Boards would do well to remember a point that the Commission has been making since before the passage of the Investment Company Act:
"Undoubtedly, the most important single attribute which induces purchases of the securities of open-end companies by the public is the so-called 'redemption feature' of such securities - that is, the assurance that the shareholder may tender his shares to the company and receive at once, or in a very short time, the approximate cash asset value of such shares as of the time of tender."3
This statement was made to the Senate in 1940.
In addition to adopting a voluntary rule, the release asks for comment on whether we should establish uniform standards for redemption fees charged under the rule. I understand that adopting uniform standards could make it easier for intermediaries upon whom funds are dependent to ensure that redemption fees are applied to shareholders in omnibus accounts. Nevertheless, I question the propriety of government micro-determinations on issues such as whether the redemption fee should be applied using FIFO or LIFO accounting and the appropriate level of de minimis waivers. To the extent possible, these issues should be sorted out by the marketplace, which remains more responsive to changes, than a government bureaucracy, even one truly seeking to do what is right for the investor. It would be unfortunate if government mandates interfered with private efforts already underway in this area.
Finally, even though the rule is voluntary, it is likely to result in the imposition of substantial costs on funds and their intermediaries. Although the cost-benefit analysis refrains from making an estimate of the costs of the rule, the Paperwork Reduction Act analysis, which considers only a subset of aggregate costs, estimated that the rule's annual cost would be nearly $631 million. This number is only an estimate compiled within restrictive statutory constraints, but at a minimum, it should cause us to sit up and take notice. We can hope that these costs will be offset by the benefit to funds and fund shareholders. The truth is that we do not know the precise parameters of the problem, let alone the magnitude of the costs of our chosen solution. This rulemaking serves as a reminder that even voluntary regimes that we set in place can impose significant costs.
It is with these concerns in mind, that I note the importance of monitoring the implementation of this rule. Both before and after the compliance date, which is eighteen months in the future, we need to keep an eye on whether investors, funds, or intermediaries are having difficulties as a result of the rule. I shall take seriously, and make referrals to Enforcement myself if necessary, any instances that investors or others bring to my attention regarding redemption fees that are excessive in amount or duration. My door is, of course, always open to anyone who has concerns, but I also hope that the Commission will undertake a more formal review to determine how the rule is working in practice.