‘Joe six-pack’ to pay for SEC pricing curbs, foes claim

The SEC's proposal to impose a "hard" 4 p.m. EST deadline for same-day pricing on mutual fund trades spurred a flood of petitions from 401(k) plan administrators and facilitators, calling for modifications to ensure a "level playing field" and protect "Joe six-pack."

As the period for public comment ended Feb. 6, some Securities and Exchange Commission officials insisted the benefits of a hard and fast cutoff time could still outweigh any drawbacks. Robert E. Plaze, the deputy director of the investment division, said his staff was "really stunned (at) the creativity — indeed, the deviousness — in the many different ways" that people were gaming the system. "Hermetically sealing the system" is arguably preferable to half measures that would leave the door open for new, improved scams going forward, he said.

Industry officials said they hope the groundswell of opposition will convince SEC commissioners to settle for a modified 4 p.m. close, an option cited in the SEC position paper that appeared in the Federal Register on Dec. 17. That option would require fund supermarkets and other intermediaries to establish tamper-proof time-stamping of orders and other procedures as a condition to offer investors same-day pricing on orders they forward to mutual fund companies long after the 4 p.m. cutoff time.

But officials admit they may be disappointed. Theresa M. Brunsman, assistant counsel of the Union Central Life Insurance Co., Cincinnati, said she gets the impression the SEC feels "very strongly about this issue," and won't be inclined to compromise.

If 401(k) participants and smaller intermediaries such as Union Central have any recourse, it will likely have to come from Congress, she said. A variety of bills with different approaches to the issue are now before the Senate, she noted.

Industry officials concede the status quo leaves too much room for late-trading transgressions, and many agree the SEC's "hard" proposal —-limiting same-day pricing to orders that intermediaries can forward to a "fund, its designated transfer agent, or a registered securities clearing agency" by 4 p.m. — would go a long way toward closing that window of ill-gotten opportunity.

The cure, though, would be worse than the disease, critics say. They argue the proposal would create two classes of investors: a favored minority enjoying same-day pricing through 4 p.m. by dealing directly with a fund management company, and a second-class majority, including 401(k) plan participants, who either would face a much-earlier cutoff to give intermediaries time to process and forward their orders or would have to accept next-day pricing.

For a crusade that began last September at the onset of the mutual fund trading scandal, that would be ironic. "It's kind of strange to punish some Joe six-pack 401(k) participant for something that some high rollers were doing," said Janice Gregory, vice president of the Washington-based ERISA Industry Committee.

Others contend the proposal will bring the arbitrage opportunity that market-timers had been exploiting with international mutual funds closer to home. "If you relegate 85% of all mutual fund investors to a 10 a.m. or noon cutoff," while the minority can still enjoy same-day pricing through 4 p.m., "you create a domestic time zone arbitrage," said Peter B. Mauthe, a director of the Society of Asset Allocators and Fund Timers Inc., Littleton, Colo., and chair of its industry relations committee.

The hard 4 p.m. rule would also alter the mutual fund industry's competitive landscape, favoring bundled providers of a single fund family's products over the intermediaries, such as fund supermarkets, that have thrived by providing investors with greater choice.

In a Jan. 19 letter to the SEC, Union Central Life Insurance's Ms. Brunsman said the proposal in its current form "will be catastrophic" for small retirement plan providers, and will "likely force companies like ours out of this market."

The longer-term fallout will be less competition in the marketplace, said Judy Schub, managing director of the Committee on Investment of Employee Benefit Assets, Washington.

The SEC's Mr. Plaze said he suspects the question of same-day pricing vs. next-day pricing won't cause that much lost sleep. "For most investors, there's no compelling reason to dump a diversified portfolio (of stocks) on any given day," he said.

In its arguments for the proposal, the SEC said, "The burden on most fund investors will be small because most are not sensitive to the time at which their purchase or redemption orders are priced. They make longer-term investments."

That's a point of contention, say 401(k) industry players. In comments to the SEC, William L. Armstrong and Clayton K. Yeutter, independent directors/trustees of the OppenheimerFunds, New York, argued the SEC was underestimating the distress that would ensue "if investors were unable to effect transactions during periods of steeply rising or falling prices — when the opportunity cost of a day's delay could be substantial."

Sept. 10, 2001, is a perfect example, said Jan Jacobson, director of retirement policy with the American Benefits Council, Washington. On that day, mutual fund investors who called in sell orders at 3 p.m. to their mutual fund companies would have gotten their money, while others who dealt with intermediaries would have had to wait until Sept. 17 — when U.S. markets re-opened following the Sept. 11 terrorist attacks — and suffered greatly from the market's plunge in the interim, she said.

The SEC's Mr. Plaze said critics might be underestimating the ability of market players to adapt — both for better and for ill.

On the negative side, Mr. Plaze said the ingeniousness of people exploiting the system's weaknesses is a big reason to consider a hard-and-fast solution.

On the positive side, that same adaptability would allow the market to eventually operate efficiently under a hard 4 p.m. rule, Mr. Plaze said. Critics are assuming that, should the SEC opt to go this route, the broker-dealer community won't adapt, but "I suspect it will," he said.

Some critics argue that the SEC's commissioners, all political appointees, will prove more receptive to the arguments in favor of a modified "hard 4 p.m." rule than the commission's professional staff.

"I think the SEC's position was that certainly a hard 4 p.m. close will fix the problem, but it's not the best solution for the majority of investors," Mr. Mauthe said. "We suspect the SEC will think a lot about their decision on this after the comment period comes to an end."

Others are less sanguine. One would think any proposal that threatens the interests of 401(k) participants and segments of the industry "would definitely be a political non-starter," said David John, a research fellow who follows the retirement industry and financial institutions at the Washington-based Heritage Foundation. But since the Enron scandal, spurred by New York Attorney General Eliot Spitzer's crusade against the mutual fund industry, the SEC's "staff seems to be running the agency," he said.

There are doubts as well that Congress will come to the rescue in a busy election year. Brian Graff, executive director of ASPA, an industry association of actuaries, record-keepers and other retirement service providers, said his organization helped sponsor legislation for a modified hard close that easily won approval in the House of Representatives. Whether the topic will develop enough momentum to pass in the Senate is an open question, he said.