Fund Execs Rail Against Redemption Rule: SEC: We Have to Find a Way to Make It Work'
March 27, 2006
PHOENIX - Michael Koonce would be happy to offer his opinion on the Securities and Exchange Commission's new redemption fee rule. It's a pain in the neck.
"This is one of the most controversial and, frankly, disruptive rules the SEC has adopted, in my experience," said Koonce, who is general counsel to Evergreen Investments, the $250 billion investment management division of Charlotte, N.C., banker Wachovia.
"It's arduous in its implementation, and it's been arduous in its creation," he said.
Officially known as Rule 22c-2 and an amendment to the Investment Company Act of 1940 adopted last March, the mandate is meant to sniff out instances of market timing that might be illegal or costly to long-term fund shareholders. Effective on Oct. 16, it allows fund companies to impose a redemption fee of up to 2% on shareholders who sell their stakes within seven days of purchase.
While the industry has embraced the spirit of the rule, fund executives have been much more reluctant to accept the baggage that comes along with it, namely a provision that orders funds to hammer out costly information-sharing agreements with all of their intermediaries. The SEC recently narrowed the rule's definition of intermediary, which, depending on the size of the fund complex, might mean that agreements would have to be brokered with only a few hundred intermediaries, rather than several thousand.
But that decision, which is currently in its comment period, comes after the SEC decided not to make the redemption fee mandatory, as it originally proposed in 2004. Instead, the regulator left it to the funds to decide whether it should be imposed.
The flip-flopping has left funds confused as to their legal obligations, as well as the ultimate cost of the rule, which has been projected at more than $2 billion industrywide and very well could go much higher.
"The rule that was adopted is in many ways the opposite of the rule that was proposed," Koonce said during a panel discussion on regulatory changes at the Investment Company Institute's 2006 Mutual Funds and Investment Management Conference, held here last week.
"From a policymaking process point of view, my belief is the reason why the rule is so difficult is that the rule has been adopted, and now we're getting to comment on some of the more difficult aspects of it," he continued. "The process just seems like it hasn't been a very good one so far."
Barry Barbash, a former director of the SEC's division of investment management and currently head of the investment management practice group at Willkie Farr & Gallagher in Washington, said the regulator's willingness to make changes to the rule is a good sign. While it's hardly any compensation as funds slug through the rule today, Barbash thinks it's a signal that the SEC will be willing to work more closely with the industry in its rulemaking tomorrow.
"If that's an indication of things to come in the future, then that's good," Barbash remarked.
Barbash speculates that one reason the rule might have been so difficult to draft is that it touches on two fund industry knowledge areas where the regulator might be weakest, operations and distribution. And it's not for lack of smarts at the SEC, he added. It's just that, due to technological leaps and other advancements in recent years, those two areas have undergone immense change at a furious pace.
But that doesn't make Barbash a proponent of the rule, either. While it might be a belated question at this point, he offered, it might be worth asking if the rule is even necessary.
"There were a whole host of rules that were designed to deal with market timing and a gazillion enforcement cases. Do we need yet another rule and one that's as operationally involved as this one?" Barbash asked.
"The world is dramatically different than it was two years ago," he added. "More focus has been placed on fair value pricing, the market has developed more tools to monitor frequent trading, and in the face of all that you have to ask, is it worth spending $2 billion, $4 billion, $6 billion or whatever it takes over three years to ferret out the last bit of frequent trading?"
Besides, Koonce continued, didn't funds previously assume that they had sufficiently guarded against market timing through dealer agreements that called for intermediaries to impose restrictions on shareholders that weren't following prospectus guidelines?
Hindsight, however, is 20/20, said Susan Wyderko, acting director of the SEC's division of investment management. She said the rule came out of a unique series of events, where there was great deal of pressure being exerted on the SEC staff from its own Commissioners, from Capitol Hill, and other external parties.
"The SEC staff looked at the situation and did the best that they could," said Wyderko, who was with the SEC's investor education arm when the rule was drafted.
Wyderko also made a point of highlighting the SEC's decision last year to step back from making the imposition of a redemption fee mandatory. Far from a flip-flop, she thinks the revision gave such an action greater weight, should a fund choose to charge one.
The change, she said, "reflected a desire to have consideration of whether a redemption fee should be imposed."
Wyderko also admits that the industry has undergone a sea change in recent years, but that's no reason to discount the rule.
"We can't forget what came before," she said, alluding to the scandal. Besides, she added, the train has already left the station.
"Our bosses voted to adopt this rule, our chairman has signaled that we are going to go ahead with this rule, so we have to find a way to make it work," she said.
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