Anyone who has driven our nation’s highways lately knows two things – gas prices are soaring, and there is a great disparity between what is being charged at different stations. In fact, knowing which stations offer the “best” (not that any of them are “good” these days) prices is the new home-field advantage, based on my recent vacation, where prices ranged as much as 23 cents/gallon in the space of less than five miles.
A similar scenario is beginning to emerge in the retirement plan market, this one triggered by the response of mutual fund firms to the mandates of the Securities and Exchange Commission – triggered by the mutual fund trading scandal. More accurately, the SEC has mandated that fund complexes either adopt a redemption fee (but not more than 2%) applied to sales of fund shares held less than seven calendar days, or determine that such a fee is “not necessary or appropriate” for the fund. In March, they also mandated that fund companies are to enter into written agreements with certain intermediaries (such as those recordkeepers/TPAs who maintain retirement plan participant records) to ensure that those redemption fee determinations are implemented; you may recall that at least one such retirement plan intermediary, Security Trust, was implicated in the first round of Spitzer charges (see STC Ex-Execs Hit With Criminal Charges; Regulators Force Dissolution at http://www.plansponsor.com/pi_type10/?RECORD_ID=23340).
The good news – sort of – is that the SEC backed off its initial mandate of a mandatory 2% redemption fee in every apparent short-term trading situation. The bad news – certainly for retirement plan recordkeepers – is that the current open-ended SEC directive seems to be creating a patchwork quilt of requirements from the fund complexes.
Plan sponsors have been slow to respond to the coming chaos, and recordkeepers, at least those who are not appended to a fund complex, seem to have been willing to adopt a wait-and-see approach (plan participants seem not to have a clue). Many, no doubt, have trusted that the industry would craft some sort of monitoring/accounting solution that would allow them to address the redemption fee issue. Unfortunately, the fund industry, left to its own devices, apparently isn’t waiting. Directives are already being issued from those complexes and, at least according to a recent report from McHenry Consulting, TPAs are beginning to take note (see Recordkeepers React to Expenses Associated With SEC Redemption Fee Rules at http://www.plansponsor.com/pi_type10/?RECORD_ID=30106). Some (notably Fidelity) have taken a particularly hard-line approach on the redemption fee issue, while even the more accommodating have issued requirements that are widely varied in the definition of amount and event(s). All in all, a potential nightmare for recordkeepers, plan sponsors, participants, and financial advisors alike.
There are alternatives, of course. The fund complexes could always determine that short-term trading isn’t a problem for fund shareholders, and thus not impose redemption fees at all. For the vast majority of funds traded in retirement plans, I think that is a plausible conclusion (the largest windfalls appear to lie in market-timing some international funds, or funds where there is a timing gap between a market valuation and fund valuation), though in the current environment, I can’t see fund boards coming to that conclusion.
Alternatively, the SEC is still soliciting feedback on its March proposal, and has specifically noted lingering questions on the use of first in, first out (FIFO) accounting in determining the holding period of the shares; a waiver for de minimis fees (say, $50 or less); application of such fees only on investor-initiated transactions; and a potential waiver for financial emergencies. The current rule, while imperfect, is not yet final, and advisors (and your partners and clients) can still weigh in.
The McHenry report suggests that that new level of awareness is leading a growing number of TPAs to consider mutual fund alternatives, alternatives that aren’t subject to the redemption fee directives, such as collective funds and exchange-traded funds. Certainly the application of redemption fees to participant accounts is, can be, and should be no less a factor in evaluating the appropriateness of an investment fund than the overall expense ratio. Even if plan sponsors have been slow to react to the potential for participant accounts being slammed with 200 basis point charges for inadvertent short-term trading activities, their participants surely won’t be.
- Nevin Adams
Note: The proposed final SEC rule is online at http://www.sec.gov/rules/final/ic-26782fr.pdf
You can comment on the rule at http://www.sec.gov/rules/proposed.shtml, or send an e-mail to firstname.lastname@example.org. You are asked to include File Number S7–11–04 on the subject line.