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Trading Abuse Curbs May Hurt Pension Plans
Dar Haddix, United Press International
August 11, 2004
The U.S. Securities and Exchange Commission should modify proposed regulations to curb mutual-fund trading abuses, or risk hurting pension-plan investors, a new Government Accountability Report says.
Mutual funds investments represent more than 20 percent of U.S. investors' pension-plan assets, the report said. Late trading and market timing result in higher costs and lower returns for long-term investors, but the effect of late trading and market timing varies among funds, partly because some funds have gone to greater trouble to prevent such trading.
With fund brokers lumping client transactions together and not sharing individual transaction details with mutual fund companies, trading abuses can be difficult to identify. To stop late trading, the SEC has proposed that all transactions be received by 4 p.m. Eastern time to ensure that all investors trade at that day's price. To curb market timing, the agency has proposed a 2 percent fee for trading fund shares within 5 days of purchase, as well as keeping records of each client's transactions in omnibus accounts.
But the new rules could increase costs for pension-plan participants, because the redemption policy would cause some investors to pay a penalty even when trades are performed with no intention of market timing.
And, necessary technology upgrades would generate costs that would be passed on to long-term investors including pension-plan participants, the report said.
Participants in pension plans sometimes borrow from their plans by selling shares. If someone borrows from a plan, pension plan record keepers have to know the value of the sold shares at the end of the day to be sure that the seller gets the amount borrowed.
The problem is that some record keepers would probably have to submit transaction orders between 12 p.m. and 2 p.m. Eastern standard time so they would have time to process transaction orders, the report said. With such orders being submitted so far before market close, participants might accidentally go over loan limits and pay penalty fees if the shares ended up being worth more than expected, or might sell too few shares to get the amount being borrowed.
Also, some plans mandate that certain shares be sold before others -- for instance, shares rolled over from a previous employer's plan, or shares purchased with participant contributions rather than employer contributions. If the plan record keeper is forced to move these shares first, the participant may end up going over or falling short of the requested loan amount.
Some pension plan record keepers expressed concern that the proposed SEC rules could make it hard for them to compete with mutual fund companies which offer in-house record-keeping services to pension plans, and could therefore place transaction orders up to 4 p.m. This could result in investors having fewer investment choices, as plans handled by record keepers often allow participants to invest in mutual funds from several mutual fund companies, while plans administered by a mutual fund company may or may not offer funds from other mutual fund companies, the report said.
Sixty-nine percent of large U.S. retirement-plan sponsors have tried to stop market timing in their 401(k) plans, the Committee on Investment of Employee Benefit Assets, an industry group, said last week. Members of the group, based in Bethesda, Md., are responsible for investment of most of the nation's largest retirement funds.
Thirty-one percent of plan sponsors have limited the maximum number of trades, 25 percent require mandatory holding periods, 23 percent levy redemption fees, 17 percent impose lock-out periods, 15 percent issue warning notices, and 12 percent use fair-value pricing.
Eighty-five percent of plan sponsors found their rules to be either very or somewhat effective at curbing market timing and/or excessive trading. The survey said an additional 14 percent of survey respondents plan to institute rules or procedures to address market timing or excessive trading in the near future.
But in some cases, fund companies have failed to stop investors from market timing. While market timing isn't illegal, the SEC has charged some fund companies with defrauding investors if the companies don't enforce their policies of discouraging or prohibiting market timing.
Conseco Inc. of Carmel, Ind. and Inviva, based in Louisville, Ky., on Monday agreed to pay $20 million to settle federal and state regulators' charges that they allowed certain investors to market time. Part of the payment will go to reimburse investors that had been hurt by the trading abuses.
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