With the deadline for complying with the rule that governs agreements between them just a week away, mutual fund companies and intermediaries are busy ironing out last-minute wrinkles.
PHILADELPHIA — With the deadline for complying with the rule that governs agreements between them just a week away, mutual fund companies and intermediaries are busy ironing out last-minute wrinkles.
The Securities and Exchange Commission’s Rule 22c-2, governing redemption fees, requires mutual funds to enter into written arrangements with potentially hundreds of intermediaries so that they will provide the funds with shareholder identity and transaction data. The compliance deadline for entering into shareholder agreements is April 16.
The idea behind the shareholder information agreements is that funds will be able to use the data to enforce restrictions on market timing.
“It’s a massive job,” Alan R. Dynner, vice president and chief legal officer for Boston-based Eaton Vance Corp. said last month at an industry conference in Palm Desert, Calif. The conference was sponsored by the Investment Company Institute of Washington.
Because many funds have multiple relationships with intermediaries — some of whom they don’t do a lot of business with — some transactions will “fall through the cracks,” Mr. Dynner said.
That’s quite possible, Andrew J. “Buddy” Donohue, director of the division of investment man-agement at the SEC, said at the ICI conference.
But the possibility of errors left him unmoved.
When issues do arise, “talk to us sooner rather than later,” Mr. Donohue said.
The SEC already has given the industry additional time to comply with the rule — it originally was set to take effect Oct. 16 — and a further extension is not in the works, he said. “I think we have given a lot of time to folks in the market,” Mr. Donohue added. At least one industry expert agrees.
“If my membership was seriously concerned about not meeting the deadline … I would have heard a lot more noise several weeks ago,” said Larry H. Goldbrum, general counsel for The Society of Professional Administrators and Recordkeepers in Simsbury, Conn. The society is a trade organization whose members handle retirement plans and retirement plan accounts.
Intermediaries don’t like the ICI model that fund companies are using as a template, Mr. Goldbrum said. It’s very “one-sided” in favor of the mutual fund companies — particularly with regards to the cost of information sharing agreements, he said.
If transaction data does fall through the cracks, theoretically, it could mean that funds aren’t given the data which allows them to catch market timers, said Jeff Keil, president of Keil Fiduciary Strategies LLC, a Littleton, Colo.-based industry consulting firm.
But even if that were the case, any market timing not detected probably would be so slight that it wouldn’t have much of an effect on the fund anyway, he added.
Market timing itself is on the way out, thanks to increased regulatory and media scrutiny, Mr. Keil said. Most funds that would be attractive to arbitrageurs have implemented redemption fees or fair-valuation procedures to discourage such activity, he said.
That is true, Eric Zitzewitz, an assistant professor of economics at Stanford (Calif.) University’s Graduate School of Business, said at the recent ICI conference.
But arbitrageurs still can make a bundle by gaming stale prices, in part because the “triggers” used by many funds — particularly international funds — to fair value their portfolios are outdated, he said. Mr. Zitzewitz’s 2001 study on stale pricing was used by regulators to show how market timing and late trading hurt long-term fund shareholders.
For example, many funds fair value their portfolios if there is a move in a target benchmark — usually the Standard & Poor’s 500 stock index — of half a percentage point or more, he said. But because the market has become less volatile over the years — the result of various factors, such as globalization — smaller moves have become more “meaningful,” to market timers, Mr. Zitzewitz said.
Although a half-point trigger may have eliminated stale prices 85% of the time before the mutual fund trading scandals broke in 2003, it now gets rid of stale prices only about 50% of the time, he said.
Although market timing in funds has declined since the mutual fund trading scandals, it can come back, Mr. Zitzewitz said. It won’t necessarily be the primary strategy that hedge funds deploy, but it could be a lucrative secondary strategy, he said.
It’s one of the reasons Mr. Zitzewitz prefers that funds not use triggers to kick off fair-value pricing but rather that they fair value prices on their portfolio daily.
It appears some in the industry agree. Interactive Data Corp. in Bedford, Mass., for example, has less than 40% of its clients — which number 146 mutual fund companies — with a “zero” trigger, said Liz Duggan, a senior director with the company.
But “we do see a large number” that have triggers of half a point or more, said Mark Heckert, a senior manager with Interactive Data.
Moving to daily fair valuation makes sense, said Russel Kinnel, director of mutual fund research for Morningstar Inc. of Chicago. But he said he doesn’t stay up nights worrying that hedge funds will be able to take advantage of funds that don’t fair value prices on portfolios on a daily basis.
