February 6, 2004
Mr. Jonathan G. Katz
Re: Proposed Rule Regarding Amendments to Rules Governing Pricing of Mutual Fund Shares; File No. S7-27-03
Dear Mr. Katz:
Dimensional Fund Advisors Inc. ("Dimensional") appreciates the opportunity to comment on the U.S Securities and Exchange Commission's (the "SEC") proposed amendments (the "Rule Proposal") to rule 22c-1 (the "Rule") under the Investment Company Act of 1940, as amended (the "Act").1 While Dimensional understands the rationale for and the circumstances prompting the Rule Proposal, and agrees that a Rule amendment is necessary to prevent the abuses that have been reported in the financial press, the abuses and problems may be better prevented through the following alternative Rule amendment: require a fund or an eligible order taker to receive all purchase and redemption orders no later than a specified time each business day (e.g., 4:00 p.m. Eastern Time), and price the orders at least twenty-four hours later (the "P+1 Alternative").
We believe this alternative is preferable because it presents the additional substantial advantage of simultaneously eliminating many "stale pricing" concerns faced by funds while still addressing late trading concerns.
Founded in 1981, Dimensional is an investment adviser registered with the SEC pursuant to the Investment Advisers Act of 1940, as amended. Dimensional is a leader in developing asset class portfolios. Dimensional currently manages approximately $50 billion for institutional clients and clients of registered investment advisers.
Dimensional, either directly or through its subsidiaries located in Sydney, Australia and London, England, serves as the investment advisor, sub-advisor and/or administrator to four investment companies registered under the Act: The DFA Investment Trust Company ("DFAITC"), Dimensional Emerging Markets Value Fund Inc. ("DEM"), Dimensional Investment Group Inc. ("DIG") and DFA Investment Dimensions Group Inc. ("DFAIDG") (together, the "Dimensional Funds"). Because of the significant amount of assets that are invested in foreign markets by the Dimensional Funds, both Dimensional and the Dimensional Funds are extremely interested in the Rule Proposal and the amendments to the Rule that will ultimately be adopted by the SEC.
The Rule presently requires mutual funds, their principal underwriters and dealers to sell and redeem shares of the funds at a price based on the current net asset value (the "NAV") next computed after receipt of an order to purchase or redeem fund shares. Additionally, the Rule requires a mutual fund to calculate its NAV at least once a day, at times approved by the fund's board of directors. The Rule Proposal would amend the Rule so that an order to purchase or redeem fund shares would receive the current day's price only if the fund or an eligible order taker receives the order by the time the fund's board of directors has established for calculating the fund's NAV. In practical effect, if adopted, the Rule Proposal would no longer permit intermediaries to forward orders after 4:00 p.m. Eastern Time.
Dimensional shares the SEC's concerns about late trading, but believes our proposed P+1 Alternative additionally addresses the SEC's other concerns (and the mutual fund industry's concerns) regarding "stale pricing." "Stale pricing" affects funds that hold international securities or securities that are traded infrequently because the prices reported for these securities at 4:00 p.m. Eastern Time, when NAVs are computed, may not accurately represent the most recent information. For example, the NAV for a fund with international securities may reflect closing prices set in foreign markets many hours earlier.2 Stale prices give market timers opportunities to profit-at the expense of long-term investors-by using information that becomes available after the stale prices are established. Of course, a fund board can address this concern (and may be required to do so, under the 1940 Act) by utilizing fair value pricing, but fair value pricing is typically more complex and considerably more costly than using market prices.
To address both "stale pricing" and late trading concerns, we suggest the SEC adopt the P+1 Alternative, which would amend the Rule to require all funds or eligible order takers to receive all purchase and redemption orders no later than a specified time each business day (e.g., 4:00 p.m.), and price the orders twenty-four hours later. Thus, an order that a fund or an eligible order taker receives no later than 4:00 p.m. on Day One would receive the 4:00 p.m. closing NAV on Day Two. This subsequent price would reflect any information from which late traders may have previously benefited under the current version of the Rule. If all funds were required to price in accordance with the P+1 Alternative, late trading abuses would be eliminated.
This Alternative would also eliminate profit opportunities created by "stale pricing" and would reduce the need for funds to fair value securities, which adds costs and complications. The P+1 Alternative would establish a trading environment where there is no informational advantage to be had from a market closing earlier than the US markets. All information about foreign markets would be captured in the 4:00 p.m. NAV and would be current based on market prices established on Day Two.
In conclusion, while we agree with the SEC's concerns, we recommend the SEC consider the P+1 Alternative. The recommendation eliminates late trading and also eliminates the opportunity for "market timing" based on "stale pricing" by guaranteeing that orders received today do not receive today's price.
Thank you for the opportunity to share our concerns and comments regarding the Rule Proposal. We support the SEC's goal of eliminating late trading but also believe the Rule Proposal can be improved to eliminate "stale pricing."
Please feel free to contact the undersigned at 310/395-8005 directly if you have any questions regarding our comments.
cc: Catherine L. Newell, Esq.