22c-2 Guidelines to Kick Start Activity
October 9, 2006
After more than a year of tensely standing by, fund companies and their go-betweens now have the guidelines they need to effectively implement the redemption fee rule.
Experts say that means the once-stalled process of executing information-sharing contract-and, more importantly, protecting investors from market timing-is about to take off.
"No one really knew what to negotiate," said Larry Goldbrum, general counsel for the Simsbury, Conn.-based Society of Professional Administrators and Recordkeepers, or SPARK Institute.
Uncertainty led to inaction, as service providers waited for contracts from fund companies, which in turn were looking for better definitions from the Securities and Exchange Commission regarding Rule 22c-2.
On Sept. 26, the SEC extended the deadline by which fund companies are expected to have information-sharing contracts in place with their intermediaries by six months to April 16, 2007, and the date by which they are required to begin collecting that data for analysis until Oct. 16, 2007-a year later than specified in the original rule.
Regulators also better defined intermediaries to only mean the service providers with which a fund deals directly, not those underlying organizations, such as 401(k) administrators or other institutional investors, thereby sharply reducing the number of contracts each fund needs to produce, and, by extension, the associated costs. Finally, the guidance allows fund companies greater leeway to negotiate what type of data they want, how often they want it and what methods they will use to analyze it.
"You're going to see a lot of activity here in the coming weeks or month now," Goldbrum said.
Much of that activity will center on shaping the terms of the intermediary contracts.
"What I haven't seen anyone do is [design] a contract that says at the get-go, Here's what we want, and here's how frequently we want it,'" said Mike Rosella, chairman of the investment management practice group at Paul Hastings in New York. Instead, contracts tend to be broadly written documents, much like the model proposed by the SPARK Institute last May.
Prematurely prescriptive contracts "set a dangerous precedent," Rosella said. Having too much information can be a curse for companies if, in fact, abuses were discovered and it became clear that a fund had the data, but did not recognize it in time to prevent the behavior.
"We tell boards all the time, Be careful what you ask for; you're bound to it,'" Rosella said.
From an investor's standpoint, a deluge of data is not only unhelpful, but costly, ultimately only driving fund expenses up, he added.
The same less-is-more philosophy applies to the provision that peels back the need for contracts between secondary and tertiary intermediaries. Even without contracts with, for example, each and every retirement plan provider, suspicious trades can be tagged, experts said.
"Once the contracts are in place, fund companies will go as deep as possible to see where market timing takes place," said Peter Delano, a senior analyst in the investment management practice at Boston-based TowerGroup.
The rule leaves it up to the discretion of the fund how often to request data, and whether to impose redemption fees of up to 2% for trades in which an investor sells shares within a time frame the fund or its intermediary finds suspicious. The March 2005 version of the rule ordered that a uniform fee of 2% be imposed on any shares bought and then sold within seven days.
Industry insiders bristled at the scope of the order-and at the cost. TowerGroup estimated that between drawing up contracts with an average of 600 intermediaries per fund, securing software and staffing, it would cost the fund industry $617.5 million to comply in just the first three years.
Contracts alone, TowerGroup estimated, would cost $288 million, after accounting for the time, legal fees and systems analysis necessary. The SEC had pegged the price of the process at $3.3 million.
"We have determined not to propose to standardize the terms or conditions to preserve the flexibility of each fund to fashion policies that are best suited to protect the investors in each fund," the 59-page final rule notes.
The SEC now estimates that the new definition of intermediary will result in each fund complex obtaining contracts from only 300 intermediaries, cost the industry $10.4 million and cause individual fund complexes to spend nine hours of service and legal staff time to comply.
Spark's Goldbrum still thinks that figure is low. "It's just going to take longer," he said.
In practice, allowing companies to control their own terms will also lower costs and actually improve effectiveness, said TowerGroup's Delano. His team has not yet estimated the new cost of implementation, but the new rules will certainly help reduce it, he said.