Sign up today and take advantage of member-only content — the kind of timely, cutting edge industry insight that only Money Management Executive can deliver.
  • Exclusive Online Only Content
  • Free Daily Email News Alerts
  • Asset Management Blogs

Redemption Rule Reaches Far and Wide: But the SEC Mandate Could Hold Hidden Treasures


As mutual fund firms prepare to meet the costly demands of the Securities and Exchange Commission's new redemption rule, known officially as Rule 22c-2, they're also discovering just how extensively it will impact their everyday business routines.

Costs related to the new rule, which at its core is designed to sniff out illegal market timing and becomes effective on Oct. 16, 2006, have been a matter of debate since the Commission ratified it last year.

For instance, Tower Group, a Needham, Mass.-based consulting firm, speculates that it 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 the $1 billion estimated by the SEC.

But fund firms are discovering that the rule will reach nearly every corner of their business and, in at least some instances, that isn't all bad.

For example, a key element of the rule demands that fund firms hammer out agreements with their intermediaries to provide detailed shareholder trading information. The document, according to a new survey by NICSA and Diversified Management Resources, could provide funds with the sales information they need to cut loose intermediaries who might not be passing muster.

"Mutual funds are already focusing their distribution models, and the legal and compliance costs associated with the agreements could exacerbate that trend," said Charlie O'Neill, a principal at Belmont, Mass.-based DMR, whose firm found that the rule would account for 25.5% of the average fund firm's technology budget in 2006.

Among the 40 money managers polled for the survey, a majority will seek agreements with intermediaries, while only 29% would seek agreements with a limited number. "There's still a lot of grousing, but funds seem committed to doing whatever it takes to meet the rule's demands," O'Neill said.

Sales details provided through the agreements might also offer funds a more accurate picture of their wholesaling force and how to compensate them, O'Neill added. Since funds would be able to scrutinize net assets versus gross assets, O'Neill offered, they'll be able to determine which shareholders in a particular territory stay on the books or leave, an important new capability in an increasingly fee-driven business.

"Of course, some people might argue that wholesalers can't control redemptions, but the other argument says they can if they're pitching the right product at the right time," O'Neill remarked. Nonetheless, he anticipates that wholesalers will likely resist any new compensation metric.

Overall, according to the study, 53% of fund firms polled said they would use the harvested data for purposes beyond busting market timers, including compliance issues other than Rule 22c-2.

But perhaps the overriding concern among fund firms since the rule was first proposed has been the number of individual agreements they would have to negotiate, as some larger money managers work with literally hundreds of intermediaries.

This month, the Investment Company Institute and the Securities Industry Association began mailing member firms a model contractual clause that their attorneys jointly fleshed out in December. According to the Washington trade groups, the model clauses can be used as either a stand-alone agreement between a fund and a broker/dealer or other intermediary, or as a supplement to an existing agreement.

The "fill-in-the-blank" clauses cover a number of items, such as the deadline for intermediaries to respond to shareholder information requests from fund firms and the cadence for delivery of that information. Funds, however, are encouraged to revise the clauses to fit their particular circumstances, they said.

In a related development, ICI and SIA member firms should also soon be receiving the NSCC Data Reporting Format, a standardized data protocol developed jointly by the securities industry and the NSCC that, by leveraging existing industry technology, would facilitate electronic transmission of shareholder trading data.

But according to the DMR study, fund firms don't appear any closer to solving the information transfer and storage dilemmas than they were last fall, when at the ICI Operations and Technology Conference in Austin, Texas, executives expressed high anxiety over liability and expense.

"I don't want to be on the hook for all that data," one service provider remarked. "It's way too expensive."

Only one-half of the respondents polled in the DMR survey reported that they employ a chief information officer to oversee management of the information, which typically includes sensitive client data like tax identification numbers and Social Security numbers. Only 33% of participants said their information security budgets have increased in the last 12 months, and 32% said they still have no liability agreements with third parties that are conducting security work.

(c) 2006 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

http://www.mmexecutive.com http://www.sourcemedia.com