A tax regulation that limits the trading of mutual fund portfolio managers would be eliminated under pending legislation, but lawmakers don't consider it a high priority.
Called the short-short rule, the regulation stipulates that no more than 30% of a mutual fund's gross income comes from the sale of securities held less than three months. If that 30% threshold is broken, the fund's income is taxable at the mutual fund level.
As a result of the rule, mutual fund portfolio managers may find themselves making portfolio decisions based on tax consequences instead of investment prospects, experts say.
In addition, the rule indirectly limits the use of derivatives in mutual funds.
David Mangefrida, tax senior manager for the Washington office of Ernst & Young L.L.P, said eliminating the rule would allow mutual fund managers to "act as they see fit for economic purposes." It would also greatly ease reporting for mutual fund companies.
James Barry, counsel for law firm Mayer, Brown & Platt, Chicago, said in agreement that the rule sometimes forces portfolio managers to look at tax considerations instead of investment considerations. But "right now it's considered more of a nuisance than anything else," Mr. Barry said.
Some derivatives markets players would like to see the rule dropped. The rule is an "economic aberration," and should be eliminated, said Jack Gaine, Washington-based general counsel and director of government relations for the Managed Futures Association, Palo Alto, Calif.
"It makes no sense," he said. He said ending the rule would open up markets to broader use by mutual funds. He said the MFA has worked very hard at getting the rule eliminated.
Alan Kaufman, chief executive of Trilogy Capital Management, Princeton, N.J., said elimination of the rule would greatly ease the creation of futures-based mutual funds. Trilogy's executives are currently working on such a project.
Alternatively, Mr. Barry of Mayer Brown said the rule might allow mutual fund managers to more easily enter into speculative positions using derivatives, even though tax law isn't the proper way to regulate speculation.
Congress may end up leaving the rule alone anyway, given lawmakers don't place a high priority on the issue. Previous attempts to strike the provision have failed, although current legislation is the furthest Congress has gone in doing so, Mr. Mangefrida of Ernst & Young said.
He said that if a tax bill is passed by Congress, it's 99% sure to be in there.
But President Clinton is threatening to veto everything in sight, and this proposal is not considered to be an essential item, he said.
Attempts to eliminate the short-short rule have been dropped many times in the past, Mr. Mangefrida said.
