Plan sponsors limit 401(k) plan trades
By Vineeta Anandand Douglas Appell
- Advertisement -WASHINGTON Some of the nations largest employers including DuPont, International Paper, General Motors and AT&T are curbing rapid-fire trades by 401(k) plan participants.
That could be a lifesaver for mutual fund companies in the crosshairs of federal and state regulators taking aim at the practice of market timing.
Those regulators, led by New York Attorney General Eliot Spitzer and Massachusetts Secretary of the Commonwealth William Galvin, have alleged violations of securities laws at some of the largest mutual fund companies.
Mr. Galvin said he will formally charge Putnam Investments within days for permitting some investors at the retirement plans of Fluor Hanford Inc., Richland, Wash.; the Boilermakers Union, Local 5, Princeton, N.J.; and the Joint Industry Board of the Electrical Industry to engage in market-timing trades, in violation of Putnams own policies.
Mutual fund company executives long have said its difficult for them to deal directly with the 401(k) plan participants at the companies for which they invest assets. But in recent weeks there have been signs the plan sponsors are stepping into the breach.
Some are restricting participants ability to dive in and out of global equity and bond funds. Others are slapping fees on investors that move quickly in and out of funds.
E.I. du Pont de Nemours & Co. Inc., Wilmington, Del., informed all 85,000 participants in its $9.3 billion 401(k) plan on Sept. 30 that it was imposing a 15-day trading restriction on two international funds in its lineup of 30 investment options. Earlier, the company had put a three-day trading restriction on an international index fund.
On Nov. 1, International Paper Co., Stamford, Conn., will begin imposing a 24-hour timeout on all investors in its approximately $3.7 billion 401(k) plan. That move is in response to market-timing trades of as much as $1 million by eight of the companys 68,000 participants that came to light about a year ago, said Robert Hunkeler, vice president and director of investments.
Investors who move among any of the companys 13 investment options would have to wait 24 hours before they could buy and sell again in any of the fund options, Mr. Hunkeler explained.
General Motors Corp., New York, charges plan investors a 1% fee on rapid trades in some of the approximately 75 investment options in its $16.3 billion defined contribution plan. A spokesman said GM hasnt experienced any market-timing abuses by participants. Still, executives imposed the fee to ensure necessary controls were in place, he said.
AT&T Corp., New York, this year began levying a penalty of 1% to 1.5% on sales and purchases made within 90 days on its five international funds, a domestic high-income fund and a low-price stock fund, a spokesman said. AT&T had $7.8 billion in its 401(k) plan as of Sept. 30, 2002, the latest statistics available. The company already had charged redemption fees for quick trades on some of the funds.
"We believe we have a fiduciary responsibility to protect the broad number of participants from the potentially adverse effect of activities by a small number of participants, said Anne Cole, manager of global benefits strategy at DuPont.
DuPont imposed the trading "fence on the Merrill Lynch International Value Fund and the Merrill Lynch Global Growth Fund last month after Merrill, its record keeper, tipped it off about the trades. The company had placed a three-day trading ban on the Merrill Lynch International Index Fund in 2000, again after being informed of the problem.
International Paper opted only for a 24-hour trading ban on all of its funds after studying research that showed the benefits of market-timing trades dissipate within a week. The company wanted to devise a method to attack the problem caused by a small number of participants without limiting the rights of most of its participants to trade, Mr. Hunkeler said.
If the one-day trading ban fails to curb the problem, the company might lengthen the ban, he said. The rapid-trading problems occurred in the companys international stock fund, the large- and small-cap domestic stock funds, and the stable value funds.
"Until fairly recently, this was not something that was on the radar screen of 401(k) plans, but in the last three or four months, mutual funds have actually come back to plan sponsors to discourage market timing, said William F. Quinn, president of AMR Investment Services, Fort Worth, Texas. AMR Investment oversees American Airlines $3.8 billion 401(k)plan.
No problem at AMR
Mr. Quinn said officials there dont face the problem of market-timing trades because they permit participants to buy and sell investments only twice a month. Nonetheless, executives have been asking the plans investment providers to detail policies they have in place to curb such trades, and the impact such trades have had on their investment returns.
A survey of large retirement plan sponsors last spring by Hewitt Associates, the Lincolnshire, Ill., employee benefits consulting firm, highlights that market timing was not in the spotlight until recently. Only 7% of the 487 plans surveyed had any kind of trading limits; 2% limited the number of trades participants could make within a week or semiweekly; and another 3% limited trades during a month.
Of the 344 plans with international funds, only 9% imposed time restrictions on trades and 2% imposed fees.
Employers also are taking note of a federal district court decision earlier this year that upheld the right of employers to impose such curbs on retirement plan investors without fear of violating federal pension law.
In Straus vs. Prudential Employee Savings Plan, the U.S. District Court for the Eastern District of New York dismissed the suit by participants aiming to stop the company and its retirement plan from blocking single rapid trades of more than $75,000 that aimed to arbitrage the impact of news events in one part of the world on share prices in other markets.
Jim Gorman, a spokesman for Prudential Insurance Co. of America, declined to comment.
The courts decision is significant because it confirms that employers may impose reasonable restrictions on trading by participants, without worrying about violating the Employee Retirement Income Security Act, said Andrew Oringer, partner in the New York law firm Clifford Chance US LLP.
Although New Yorks Mr. Spitzer has led the charge, Mr. Galvin grabbed headlines last week with his looming action again Putnam and his continued investigations of other large mutual fund groups, including Fidelity Investments, Franklin Resources and Morgan Stanley.
"Our contention is that when you give somebody a prospectus encouraging them to invest, youve made a contractual commitment. If you breach that commitment, then youve committed fraud, Mr. Galvin said in an interview.
A prospectus for the Putnam International Capital Opportunities Fund clearly states that short-term trading is disruptive, and it imposes a 1% fee on movements within 90 days to discourage such trades. Moreover, the prospectus also says that Putnam may ban the trading privileges of investors or reject rapid-fire trades.
Joseph Gregorio, trustee for the Boilermakers Local 5 plan, declined to comment. Segal Advisors, the investment consultant to that and the electrical industry plan, also declined to comment.
Meanwhile, the Securities and Exchange Commission is expected to propose rules in a few weeks that would require mutual fund companies to explicitly state their policies and procedures to curb market-timing trades by investors in their funds. The SEC will not require mutual funds to have policies aimed at curbing market timing, but it will require those that do to specify the circumstances under which they would reject trades that aim to game the system by anticipating market reactions to events in different time zones.
"Currently, funds have a lot of wiggle room to determine which trades they may permit and which they may reject, said Doug Scheidt, associate director in the office of the chief counsel in the SECs division of investment management.
The SEC also is likely to finalize rules requiring mutual funds to institute fair-value pricing, in which the firms adjust the prices of shares, especially of international funds, to reflect the impact of the days news events after the closing of foreign stock markets.
The new rules also would hit retirement plan administrators, who need to submit all orders from participants to the funds before 4 p.m Eastern time, or the funds deadline for accepting trades (if earlier) in order to prevent late trading abuses.
If administrators need the funds closing price to figure out if they can accept a participants order, they would need to base their calculations on the previous days price, or simply hold the order until the following day, said Mr. Scheidt.