July 2, 2006
Dear Sir or Madam,
I am writing today in reference to proposed rule 22c-2. I would like to provide comment on this rule as it relates to short-term redemption fees and how these fees are in conflict with the SECs historic vision as laid out in the Advisors Act of 1940 and further how these fees are in conflict free market philosophy.
The SEC has long held to the principal that advisors must treat all clients fairly overtime, i.e., advisors may not favor any client or group clients. Further, advisors may not act in such a manner which would result in the advisor being favored over their client. I submit that this is exactly the effect that short-term redemption fees play on investors who choose to invest for a limited period of time.
Recent history has shown that there has been a negative view associated with those investors who choose to invest in open end mutual fund for a limited amount of time, generally referred to as short-term traders or market timers. Investors who may recognize opportunities based on market movements, whether in a security or index. Individuals who understand arbitrage and other strategies have been made out to be the pariah of the industry. Advisors as well as others blame these individuals for additional trading costs but it should be noted that short-term traders are relatively few in numbers compared to long-term traders and the trade costs which advisors speak of pale in comparison to the cost of hidden fees paid by long-term shareholders.
The true concern about this rule is that it forces advisors to favor its long-term shareholders over-short term share-holders, which I believe is in direct violation of the Investment Advisors Act of 1940. Is it anymore fair that long-term shareholders might pay additional trade costs due to the activity of short-term investors and that short-term investors may have to pay higher redemption fees or loose alpha because they must stay in an investment to avoid higher fees? In either case one client is always being favored over another client and the only way to be fair is to favor no client and charge no redemption fees. Further, due to the fact that advisors are paid fees based on AUM, the quasi-lockup up period created by redemption fees (most funds seem to be choosing two month investment limit in order for shareholders to avoid paying a fee ) helps to create a state in which the advisor is favoring itself over its clients which is also a direct violation of the Advisors Act of 1940. This is the case because advisors will receive higher fees form clients due to investors maintaining investments in funds they would have otherwise gotten out of if there were not a short-term fee.
My second concern is that this rule violates our philosophic ideas related to a free market system. For a free market economy to operate successfully all investors must have unfettered access to enter and leave the market. This proposed rule stands in direct contradiction to this idea. Why should the long-term shareholder be so cherished over the short-term shareholder? Being short-term is nothing new, thousands of traders everyday move into and out of positions quickly and the system works because we have not created barriers. The point of any investor is to make money, why then in the world of open end mutual fund should this be the sole providence of investment mangers and not the investors themselves? Why should mutual fund shares hold a special distinction limiting investors and their ability to profit from a product?
I believe that if the SEC wants to truly help investors they would focus more on fees, especially hidden fees paid by fund shareholders. The SEC has already taken great steps in this area by changing rules related to soft dollars. The SEC should force the industry to explore transparency of fees which would include a requirement for advisors to outline all underling fees for each portfolio. Because at the end of the day it is these fees which truly hurt shareholders as John Bogle, President of Vanguard noted (please see transcript below)
Thank you for your time and for consideration of my ideas.
6565 W English Meadows Dr
Greenfield WI 53220
Just how much does a fund company make from investors who hang in there for the long term? John Bogle, the founder of the very successful Vanguard Group, shed some light on that.
He was asked by an interviewer with the TV program "Frontline," "What percentage of my net growth is going to fees in a 401(k) plan?" Bogle replied, "Well it's awesome. Let me give you a little longer-term example. An individual who's 20-years old today is starting to accumulate for retirement.... That person has about 45 years to go before retirement -- 20 to 65 -- and then, if you believe the actuarial tables, another 20 years to go before death mercifully brings his or her life to a close. So that's 65 years of investing. If you invest $1,000 at the beginning of that time and earn 8 percent, that $1,000 will grow...to around $140,000."
He continued: "Now the financial system -- the mutual-fund system in this case -- will take about 2.5 percentage points out of that return, so you'll have a net return of 5.5 percent, and your $1,000 will grow to approximately $30,000 to you the investor."
"Think about that. That means the financial system put up zero percent of the capital and took zero percent of the risk and got almost 80 percent of the return. And you, the investor in this long time period, an investment lifetime, put up 100 percent of the capital, took 100 percent of the risk, and got only a little bit over 20 percent of the return. That's a financial system that's failing investors because of those costs of financial advice and brokerage, some hidden, some out in plain sight, that investors face today. So the system has to be fixed," said Bogle.