1st Global Capital Corp.February 6, 2004 Submitted electronically to rule-comments@sec.gov Jonathan Katz, Secretary
Re: 1st Global Capital Corp comments on SEC proposed rule amendments governing pricing of mutual fund shares
Dear Mr. Katz: 1st Global Capital Corp. ("1st Global") is a fully disclosed retail broker-dealer registered to conduct business in all domestic jurisdictions, with over 1,200 Registered Representatives offering securities services through nearly 600 branch and non-branch locations. As the Chief Executive Officer of 1st Global, I appreciate the opportunity to submit comments on the issues raised in the above captioned proposed rule amendments by the Securities and Exchange Commission ("Commission"). Late trading is unequivocally illegal and abhorrent and we applaud the strong enforcement actions the Commission and other regulators have taken to punish wrongdoers. We believe that these enforcement actions and the broad attention they have received have had a significant deterrent effect on potential wrongdoers and have propelled broker-dealers, other financial intermediaries and mutual funds to focus their compliance efforts more sharply on preventing late trading. We also understand and support the need for additional measures to prevent late trading. However, we are strongly opposed to the proposed amendments or any attempt to mandate an order acceptance cutoff tied to the time the fund has set its net asset value for the day (the "hard close") where the broker-dealer executing the trade is not recognized as one of the intermediaries qualified to accept the order up to the hard close. Such a provision will provide mutual fund companies an unfair and unwarranted competitive advantage over other market participants. We cannot ignore the irony of the potential situation wherein the very party that has spurred regulatory action ends up with a competitive advantage-in effect having regulations created that reward mutual fund companies at the expense of their intermediaries. As the Commission so eloquently stated in the proposal, "Fund managers themselves have permitted late trades by favored investors."1 Why then is the Commission proposing amendments that will elevate those same mutual fund companies to a favored position with respect to the selling of their shares? We believe the more appropriate course of action is to adopt amendments that follow the alternate approach referenced in Section II of the Commission's proposal ("alternate course"). In addition, we would also support a modification that includes the home office of a registered broker-dealer on the list of hard close eligible entities, along with the fund, its designated transfer agent or a registered securities clearing agency. In addition to the concerns about competitive advantage noted above, we are also concerned with the administrative and supervisory issues that will result from the proposal. Administrative Issues In the proposed release, the Commission recognizes that requiring a hard close at the fund level would likely necessitate that intermediaries establish an earlier (pre-close) cut-off time for investors to submit fund orders and obtain current day pricing. "...Intermediaries will likely require investors to submit purchase orders at an earlier time in the day (e.g., 2:00 p.m.) to obtain the 4:00 p.m. price, in order to allow the intermediary time to process the purchase and redemption orders before submitting them to the fund, its designated transfer agent, or the clearing agency.2..." This earlier cutoff would be necessary to allow broker-dealers to perform all necessary order reviews prior to the hard close. Among other things, that would include analysis to assure that any sales discounts (breakpoints) are properly applied. Even though many checks can be performed electronically (account linkage, Rights of Accumulation, Net Asset Value (NAV) Transfers, and NAV Reinstatements), much of the process is still manual. Because of the numerous and varying rules that each fund group follows, many orders need to be held in the firm's computer system for review before they are sent to the NSCC via the Fund/SERV system, and ultimately on to the fund. The risk is that if the orders are not properly reviewed, investors may not receive the discounts to which they are entitled.The net result of the earlier cut-off time is that the vast majority of fund shareholders who either prefer, or have no alternative but, to deal through intermediaries would be denied the ability to effect purchases at current day prices for at least a portion of, and possibly an entire trading day. Correspondingly, with redemptions, shareholders would be exposed to an additional day of market risk. The proposed release suggests that these earlier cutoff times would not impose a significant burden on most mutual fund investors who are making longer term investments, frequently through 401(k) plan payroll deduction which are random events and which essentially provide dollar-cost averaging.3 We agree with the Commission's analysis as it would apply to "periodic" purchases to or withdrawals from fund retirement plans. However, that analysis fails to address the most substantial risk - the inability to liquidate in a timely fashion a large mutual fund portfolio in a rapidly declining market where the liquidation decision is made after the newly imposed artificial trade deadline but before market close. Supervisory Issues We are also concerned about effects such modifications will have on general supervisory issues associated with trades for accounts held directly by the mutual fund company.4 Mutual fund companies that offer their shares exclusively with a load structure have universally set up their customer service and trading operations to facilitate direct interaction with clients and registered representatives. They have done this with little regard for the supervisory issues that face a typical retail broker-dealer. Their rationale is that it is solely the concern of the retail broker-dealer. 5 While seemingly fulfilling the need of clients and registered representatives to have instant access to their investments and the investment accounts they oversee, it creates a supervisory quandary for the retail broker-dealer. If orders are placed directly with the mutual fund company, how are those orders being supervised? 1st Global, as an independent broker-dealer, has devoted significant resources in an effort to ensure that our registered representatives place all orders with us as opposed to placing those orders directly at the mutual fund company. That process optimizes our supervisory capabilities. We believe the proposal will actually work to promote placement of direct business with the mutual fund company and bypass the retail broker-dealer. The proposal will thereby alter the current environment to create an artificial incentive for shareholders to deal directly with the mutual fund company to the exclusion of the retail broker-dealer. For example, if a registered representative receives authorization from a client to execute a mutual fund order for a client that has a retail direct, non-brokerage account at 3:58 PM E.S.T. and his choice is to call it in directly to the mutual fund and receive that day's price or call it in to his broker-dealer and receive tomorrow's price, what will he do? With an understanding from a regulatory perspective that he must process orders promptly and with a desire to provide superior customer service to his client, he will likely call the transaction in to the mutual fund company. The risk is that unsupervised orders will be the path of least resistance. Under the current pricing rules, the registered representative does not have to make this choice. If the proposal is adopted without modification, the rep will be forced to make this choice. We strongly urge caution in proposing and enacting any amendments that will create a situation where the ethical and client-centric course of action results in regulatory problems. If a hard close is adopted without an exception for orders effected through broker-dealers, we encourage the Commission to include in its amendments provisions to prohibit mutual fund and variable insurance separate account companies from either: Accepting telephone or internet orders directly from registered representatives unless they have validated in writing with the broker-dealer's home office that the order is coming in from an OSJ (a) (b) Opening accounts via a subscription way methodology unless they have verified in writing with the broker-dealer's home office that a registered principal located in an OSJ has approved the application In summary, we are strongly opposed to the proposed amendments or any variation that contains provisions for a hard close where the broker-dealer executing the trade is not recognized as one of the places of acceptance. Such new regulations would create an anti-competitive business environment, with negative consequences to clients and the investing public at large. The regulations would also generate significant supervisory issues that would also negatively impact the client. We believe a less draconian solution, namely the alternate course discussed in the proposal, could achieve the desired goal. Again, we thank the Commission for the opportunity to comment on these important issues. Sincerely, Stephen A. Batman
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