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Operations' Role in Fund Reform


Last year began well enough. But in September, as the first shock waves hit, scandals were revealed and other problems within the fund industry became front-page news, the year turned somber. Investigations escalated, and the U.S. Senate Banking Committee trained its eye on the unfolding chronicle of late-trading and market-timing abuses, launching a series of information hearings with every sector of the industry.

When the Securities and Exchange Commission, in its proposal to amend Rule 22c-1 on forward pricing, cited National Securities Clearing Corp. (NSCC) and its Fund/SERV system as a possible solution, the Committee sought us out. Processing a peak volume last year of 87 million transactions valued at $1.5 trillion for more than a thousand fund companies and intermediary firms, the Committee wanted to know how this operational engine could play a role in solving the problems of late trading and market timing.

Way before our invitation to speak to the Committee, the Depository Trust & Clearing Corp. (DTCC) and NSCC had been consulting with the SEC, with customers and with industry trade groups to clearly understand the operational issues associated with late trading and market timing. With so many signs pointing to the advent of new regulations, it was critical that we be able to identify how Fund/SERV could support our customers in a changing processing environment.

At a hearing before the Committee in March, we testified that if Fund/SERV were to receive orders by the 4 p.m. close of business as suggested by the SEC, we could easily handle the orders. We had already tested our system's capacity and knew that it could handle a potentially huge concentration of orders within the half-hour just prior to 4 p.m. We stepped forward with a recommendation to enhance the system with a timestamping safeguard to verify time of receipt. Based on rounds of discussions with our industry partners, we felt strongly this recommendation spoke to the needs of the broad industry and could help minimize the costs individual firms would have to incur in their operations areas to meet new regulatory requirements.

To do this, of course, would mean making modifications to Fund/SERV, including:

Creating a uniform methodology to record the time each file and order is received.

Enhancing the system to recognize the intent of the trade as of the 4 p.m. deadline, or, in other words, the exact elements comprising a complete, valid and unalterable trade.

Adding functionality to allow intermediaries to transmit later in the day ancillary data that is usually not known until after 4 p.m., such as breakpoint information.

We believe that applying a hard 4 p.m. close at NSCC is far better for investors than applying it at the fund or its transfer agent. However, we maintain that leaving the responsibility for timestamping at the intermediary level with safeguards to prevent late-trading abuses would preserve the flexibility currently afforded to all mutual fund investors.

Defined contribution transactions pose an additional level of complexity, but it is not insurmountable. We are discussing with the SEC possible solutions so that investors in these types of plans would not be placed at a market disadvantage.

Last year, when the Joint NASD/Industry Task Force on Breakpoints pinpointed both Fund/SERV and another NSCC service, the Mutual Fund Profile Service, as critical to an overall solution, we set to work immediately. The result was systems enhancements that we have already begun to roll out to the industry and that will continue throughout the year.

During this process, DTCC made two critical decisions. The first was to rethink and retool the Mutual Fund Profile Service and bolster its ability to house a much broader range of breakpoint and other security-related information than before. The second was to strike an agreement with the data technology company NewRiver to populate Profile with the latest information from SEC filings. This approach frees fund companies from an onerous and highly detailed process, and places the information in a single database available to broker/dealers and other intermediaries.

The playing field is changing and becoming more complex. Faced with the necessity of complying with new regulations, the mutual fund world may have to rethink how it runs its back office. For DTCC and NSCC, we see our lead role as staying ahead of the curve of change so that we can continue to provide the fund industry with operational solutions to increase efficiencies, lower costs and minimize risk.

Ann Bergin is managing director, distribution services, for Depository Trust & Clearing Corp.

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