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Questions Abound About New SEC Regs


SAN ANTONIO -- The Investment Company Institute held its annual Tax & Accounting conference in 2003, just nine days after the scandal broke last year amid a cloud of controversy and confusion and long before the full scope of Fundgate would be realized by the industry.

One year later, and firms are still struggling with several regulations and a lack of clarity surrounding important issues to the future of the industry.

"While the darkest days of the scandal are likely over, we are still digesting some of the regulatory responsibilities," said Joe Carrier, vice president and treasurer of T. Rowe Price Funds and chairman of the ICI Accounting/Treasurers Committee. "The challenges we are facing are steeper than ever. There are a lot of demands on our resources."

One of the major issues still facing the industry is market timing, which along with late trading, were the two focal points of the initial phase of the scandal. While there have been several enforcement actions by the Securities and Exchange Commission against firms where their actions pertaining to timing were in contradiction to the language in the prospectuses, there is no widely accepted guideline to define market timing. It is generally considered to be exchanges in and out of a fund in excess of the number of allowed roundtrip trades in the prospectus.

However, firms have all different guidelines. Some limit the number of trades over a period of 30 days, while others restrict the roundtrips over the course of a quarter. Still others judge activity over the course of a year. Because the guidelines from shop to shop vary widely, finding a solution could prove to be difficult. "That's going to be a mess for a while," said David B. Jones, senior vice president at Fidelity Management & Research Co., speaking on a panel on regulatory developments. Jones said firms should not look to regulators to define market timing. "I don't think we'll see the SEC defining market timing. We'll probably have to do that ourselves," he said. As a result, he is calling for the industry to create best practices in this area.

Pointing Fingers

Confusion surrounding accountability also seems to be prevalent. Jones said firms need to know who is responsible for fund processing "out in the field," referring to broker/dealers, banks and retirement plan recordkeepers, among others. "We're all talking with recordkeepers to find out how they're dealing," he said. However, according to a survey Jones cited, industry counterparts "out in the field" are not doing so well. The survey found that 49% of retirement plan recordkeepers couldn't track market timing and another 60% said they couldn't track redemption fees. So, while the industry has emphasized its renewed fiduciary culture and new rules, many of its partners lack the ability to stomp out timing or to implement SEC-required provisions aimed at deterring the activity.

"We could use a little more help from the SEC with getting brokers to listen to us a little better," Jones said, noting that brokers have become more receptive than a year ago, but there still needs to be improvement. "We've told third-party recordkeepers that they need to collect [redemption] fees just like everybody else," Jones said. "It's still not clear what responsibilities intermediaries have. We have a lot of responsibility."

Jack Murphy, a partner at the New York law firm Dechert, had numerous questions about the future of revenue sharing and about the logic behind the recent Bridgeway Capital Management enforcement action, which pertained to the calculation of performance-based fees.

While conceding that directed brokerage is dead, he said "brokers will still insist on being paid." Additionally, broker/dealers will continue to charge as much as the traffic will bear, and while they prefer hard dollars, soft dollars will do in a pinch. So, revenue sharing is unlikely to disappear, but it is still murky to executives in the industry as to what arrangements are allowed. Murphy said revenue-sharing arrangements are becoming more formalized and contracts detailing dollar amounts and services are becoming more prevalent. However, informal agreements have given rise to a lot of uncertainty, he claims.

As for the performance fee issue, Murphy said the Bridgeway settlement is the first in a long pipeline of similar cases the SEC is prepared to bring. He said a SEC staffer has told him as much.

Bridgeway and its president, John Noland Ryan Montgomery, agreed to pay about $5 million to settle charges of collecting illegally calculated performance-based fees from investors in three of its mutual funds. The firm charged investors fees based on the current value of the funds, instead of the trailing five-year period, and overcharged approximately $4.4 million in fees, according to the SEC.