Fund Industry Braces for Redemption Day: Cost of Rule 22c-2 is Staggering; Who Accounts for What is Unclear
October 31, 2005
AUSTIN, Texas - The deadline for mutual funds to implement agreements with intermediaries to accommodate the Securities and Exchange Commission's Rule 22c-2, or the redemption fee rule, is an entire year away, but experts have this message for the industry: If you haven't begun preparations yet, you're way behind.
Judging by a show of hands during a panel discussion on the anti-market-timing rule at the Investment Company Institute's 2005 Operations and Technology Conference, held here last week, funds and intermediaries that are way behind enjoy plenty of company.
Passed earlier this year, the rule's underlying intent is to identify funds and trading partners that might allow market timing. However, it has been characterized as "watered-down" because of its voluntary nature. In fact, industry executives admitted behind closed doors that the redemption fee itself is of little concern among rapid traders. Apathy toward the rule, however, doesn't appear to be to blame for the industry's reluctance to prepare for it. It can be terrifyingly expensive, for starters, because on top of paying costly legal teams to hammer out agreement language between fund firms and their hundreds of intermediaries, there's a pricey technology solution ahead for securely transmitting crushing levels of trading data.
"I just don't have millions of dollars to spend on this," said Gail Weiss, president of Gail Weiss & Associates, a Baltimore-based consulting group and service provider.
With thousands of trades executed daily, reams of additional data would need to be stored, presumably by a "first-tier intermediary," which in itself is a puzzling designation. According to the SEC, that would be "any entity that holds shares in nominee name or maintains records for a participant-directed retirement plan."
"I don't want to be on the hook for all that data," Weiss remarked. "It's way too expensive."
Meanwhile, the industry must also devise a means to compel service providers that occupy the bottom of the fund chain to hand over trading information in a timely manner. Resources must also be dedicated toward harvesting the redemption fee and for sitting on the cash once it's collected - tasks that appear to again fall in the laps of intermediaries.
"How do I account for the redemption fee money?" Weiss pressed further. "What if the participant leaves the fund? Who tracks down the money? And what about e-mailing all those tax I.D. numbers and Social Security numbers back and forth? There are security issues that need to be addressed."
Tower Group, a Needham, Mass.-based consulting firm, recently estimated that the rule could cost the industry upwards of $617.5 million over the next three years. Denver information manager Fiserv, however, has estimated that the total cost on an annual basis would be $2.3 billion, or more than twice than the $1 billion the SEC estimated.
Craig Kolzow, vice president of asset management and client services at broker/dealer Charles Schwab, said his San Francisco firm can hardly afford the rule's costs, either. Nonetheless, he said Schwab has already begun enforcing the rule at various levels.
"Our difficulty is determining exactly what market timing is," Kolzow said.
Schwab also began building a Web portal to accommodate the exchange of trading information between itself and its partners two years ago. An SEC representative who was on site when the portal launched remarked that watching the information stream was "like getting hit with a fire hose of data."
On an industry-wide scale, the data dump would indeed be nightmarish. As such, the Investment Company Institute has formed a committee on data industry standardization. John Villegas, vice president of trading and accounting at recordkeeper ADP in Roseland, N.J., said the goal is to devise two standardized trade reporting forms, one based on a DTCC platform and another for use by non-DTCC members.
"But with some 600 to 800 forms going out to intermediaries and 600 to 800 forms coming back, we'd like them to be as similar as possible," Villegas said.
The DTCC solution will arrive in the January-February timeframe, which would allow for a six-month rollout and two months of testing before the Oct. 16 deadline.
How often funds might make requests for trading information is unclear, but Laura Chasney, associate counsel for T. Rowe Price of Baltimore, would hope it's as infrequent as possible. "I can't imagine getting the information on a daily basis," she said. "That would be millions of a accounts."
The forms should allow for a nine-day turnaround on trading requests, which Kolzow admitted would do little good in preventing a market-timed trade. Instead, the timer would be put on a watch list.
"The goal would be to prevent future market timing," he said. "If we could forecast market timing that would be great, but we just can't."
In the meantime, funds should be identifying intermediaries that have omnibus and/or nominee accounts and drafting agreement language for a model contract. They should also determine how often they want trading information and how they'll handle non-compliant intermediaries. Intermediaries, meanwhile, should be determining whether they're a first- or second-tier player and what resources might be needed to enforce 22c-2 and keep its records.
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