WASHINGTON -- A Labor Department proposal could save pension funds hundreds of millions of dollars a year in trading costs.
The department's pension office has proposed letting quantitative and passive money managers swap securities among different investment portfolios, including those that contain pension fund assets.
The regulator's proposal would exempt index and quantitative money managers from provisions of federal pension law that forbid them from swapping securities, or "cross trading," among portfolios of pension fund and non-pension fund clients.
The proposal could save pension plans millions in transaction costs they otherwise would incur.
Under the proposal, money managers would be allowed to swap securities among non-pension fund portfolios and separate accounts with more than $50 million in pension assets.
Passive managers would be able to cross-trade so long as they try to replicate standard indexes such as the Standard & Poor's 500. And quantitative managers would be required to base their computer models on prescribed objective criteria using outside data not within the control of the money manager.
Federal pension law typically prohibits pension fund investment advisers from representing both the seller and the buyer because of concerns they might favor one client over the other and could benefit financially from transactions that might not be in the best interests of plan participants.
Until now, the Labor Department has allowed money managers to cross-trade on a case-by-case basis, but has not issued any new exemptions for several years.
Investment advisers managing retirement plan assets in mutual funds can cross-trade freely.
"We generally think it is positive," said Joanne T. Medero, managing director and chief counsel at Barclays Global Investors. The San Francisco-based firm is the world's largest manager of index strategies, and manages more than $400 billion in U.S. pension assets.
A. Richard "Brick" Susko, partner in the New York law firm of Cleary, Gottleib, Steen & Hamilton, agreed.
"It is important that pension funds avoid transaction costs, yet buy and sell securities they want in an efficient manner. This permits them to do that," he said.
But active money managers and groups representing them are dismayed because the Labor Department's proposal does nothing to exempt them from the self-dealing and conflict-of-interests provisions of the Employee Retirement Income Security Act.
"It doesn't really solve the problems for our type of members," said Karen L. Barr, general counsel at the Investment Counsel Association of America, Washington. Most of the ICAA's members run actively managed portfolios.
The Labor Department has announced plans for a February hearing to decide whether to craft a similar proposal for active money managers. But sources in the money management industry said they are unsure such a proposal will fly.
In fact, the Labor Department's proposal makes it clear its concerns about money manager conflicts of interests "are more apparent in situations involving actively managed accounts or funds, where an investment manager has total investment discretion to choose particular securities."
"Many members are concerned about their ability to perform active cross-trading(for their pension clients), so we're a little disappointed the department has split the project into two pieces," said Russ Galer, senior counsel at the Investment Company Institute, the Washington-based trade association for the mutual fund industry.
Putnam Investments, Boston, which has all but given up expecting the Labor Department to act on its 1997 application for permission to cross-trade among actively managed pension fund portfolios, hopes the regulator will realize pension funds stand to gain more from cross-trading than they stand to lose, said Ralph Derbyshire, senior vice president and chief ERISA counsel. Putnam runs about $100 billion in ERISA assets outside of mutual funds.
"I'm unhappy to say that this proposal does not provide any comfort to T. Rowe Price, or for that matter the majority of investment advisers and plans that responded to the Labor Department's original notice" for input, said David M. Abbey, vice president and associate legal counsel. The Baltimore-based mutual fund firm invests $16 billion of pension fund money in separate accounts.
T. Rowe Price Associates has had a request pending before the Labor Department for several years for permission to cross-trade securities among actively managed portfolios of pension fund clients.
Concerned about standard
Mr. Abbey also is disturbed that the Labor Department's proposal is more stringent than some of the individual requests it previously has granted. Because the class exemption does not overrule those earlier exemptions, it could create two sets of standards, he said.
For example, the proposal's definition of index managers excludes enhanced index managers that tilt their portfolios by market capitalization of companies or favor particular investment styles. But enhanced index managers that already have Labor Department permission to cross trade would be able to continue doing so unless the regulator rules otherwise, a Labor Department spokesman said.
Mr. Abbey and others also are worried the proposal does not follow the standards laid out by the Securities and Exchange Commission, which regulates non-pension-fund cross-trades.
Thus, while the Labor Department's proposal requires the money managers cross-trade at a security's closing price, Section 17a-7 of the Investment Company Act of 1940 permits money managers to cross-trade securities at the "current market price."
The Labor Department's proposal would require money managers to get annual permission from independent plan fiduciaries to conduct cross-trades, and to notify independent plan fiduciaries about changes in indexes and other events that would prompt cross-trading. After the initial permission has been received, money managers can assume they may continue cross-trading unless the independent fiduciaries specifically say they can't.
And, the securities being swapped among clients must be widely held, actively traded and market quotes for them must be readily available.