T. Rowe Price's decision to bar a group of American Airlines employees from trading in their 401(k) plans may point to ways for fund firms to protect themselves and plan sponsors from potential liabilities.
The firm banned 1,300 employees of the airline from trading in funds in the company's retirement plan in an attempt to deter mass trading by a group that subscribes to EZTracker, an investment newsletter for airline employees, according to a report from Reuters. Another 800 workers were warned about their trading activity.
Not the first time
The newsletter's recommendations have shaped trading activity in the past: In April, EZTracker suggested participants sell out of T. Rowe Price's high-yield fund, five months after suggesting readers buy it, according to Reuters.
Though it's entirely up to a plan participant how he or she decides to invest, fund families and plan sponsors can be at risk when investors use their 401(k) accounts to trade en masse.
“Trading restrictions are nothing new,” said Fred Reish, partner at Drinker Biddle & Reath LLP. “The last time people talked about this was in the late 1990s and early 2000s.”
Back then, the Securities and Exchange Commission and other regulators dropped the boom on mutual fund families due to charges of trading irregularities. Companies swept up in the controversy in-cluded Putnam Investments, where certain 401(k) plan participants were allowed to shuffle money across different funds and participate in market timing and excessive short-term trading.
Retirement plan providers with participants who time the market are at risk, since participants who don't partake in the activity can pursue the mutual fund family in court and allege that the market-timers have an unfair advantage, noted Marcia Wagner, a managing director with The Wagner Law Group.
Companies have since taken steps to curtail such actions. In the 401(k) space, for example, record keepers and fund managers can impose bans on trading. T. Rowe put language in its fund prospectuses in 2010 to allow the funds to reject trades that could dilute the value of the funds' shares, according to Reuters.
T. Rowe Price's spokesman Bill Benintende said the firm has a fiduciary obligation to protect the interests of shareholders against excessive trading “that may disrupt
portfolio management and negatively impact performance.”
'Several warnings'
“In this case, we issued several warnings about excessive trading by a small minority of plan participants over a period of years,” he said. “Ultimately, to protect fund shareholders, we permanently banned these participants from exchanging money into the T. Rowe Price funds in the plan.”
Mr. Benintende said the participants still are allowed to invest new money into the funds via payroll deduction, and they can redeem money from the funds at any time.
Another issue is that the plan sponsor doesn't want to be left holding the bag if the trades go wrong.
“This comes down to fiduciary prudence, either protecting participants from themselves or making sure that they don't gain leverage over others and short sell,” Ms. Wagner said.
Paul Flaningan, a spokesman for American Airlines, said: “When we spoke with T. Rowe Price about the activity of a smaller group of about 1,300 participants, the fund managers explained the rules of the prospectus and the impact of this group to all plan members. American supports licensed financial advice for all of the participants in our Super Saver plan.”
Frequent traders can cause other inconveniences: Fund managers may need to buy and sell stock to accommodate the activities of those who trade regularly, Mr. Reish added.
A permanent ban on trading raises the question of what happens to the participant who was trading as part of a longer-term strategy and is now trapped in an allocation that could go out of vogue. Mr. Reish said, hypothetically, a fund provider could permit investors to sell out of their position and move to cash.
The odds aren't in the favor of participants who decide to sue fund providers for imposing such bans, leaving them stuck, Mr. Reish said.
“Broadly, if the restrictions interfere with legitimate long-term investing and proper asset allocations, then the fiduciaries should consider removing the mutual fund,” he said. “The mutual funds themselves are pretty well-removed from the fray and can go by the rules in their prospectuses. I think the court would side with the mutual fund provider and the record keeper.”
