Rule Targeting Rapid Trading to Swell Costs

May 3, 2006
The Securities and Exchange Commission’s proposed solution to stem rapid trading in mutual funds is likely to result in increased costs and work for employers with 401(k) plans and make them the de facto enforcers of fund companies’ policies.

In March 2005, the SEC proposed a rule that would require employers or the companies that administer their 401(k) plans to disclose the identities of the employees in the plans. The move was in response to an investigation by New York Attorney General Eliot Spitzer, who found that some fund companies were allowing investors to engage in rapid trading of their mutual funds, to the detriment of other account holders.

Currently, 401(k) plans are part of omnibus accounts, which are large accounts that get price discounts for transactions because of their size. As such, the individual employees in the accounts are not identified.

By requiring intermediaries to identify the employees in the plans to the companies that manage the funds, the SEC is creating a "nightmare for fund companies and vendors," which now have to create systems to handle the process, says Don Stone, president of Plan Sponsor Advisors, a Chicago-based consultancy.

In response to industry concerns about the complexity and costs, the SEC has amended the rule to limit the number of information-sharing agreements that fund companies would need to have with intermediaries.

But for employers, this change won’t matter, says Brian Graff, executive director of the American Association of Pension Professionals & Actuaries, a Washington, D.C., lobbyist that represents more than 5,400 defined-benefit and defined-contribution plan professionals. Building the required systems and sending the data "is going to increase the costs for both plan sponsors and participants," he says.

In its amended proposal, the SEC estimates that the rule will cost funds and intermediaries $274.5 million in one-time startup expenses and $161.5 million annually thereafter.

Fiserv, a 401(k) custodian, has not yet determined how much the requirement will cost the firm. "The problem is that we can’t determine the costs until this rule is hammered out," says Michael Rice, manager of third-party administrator services at Fiserv Trust Services.

"It’s definitely going to be expensive, and there will be an overall increase in plan costs," he says. "But I couldn’t venture by how much until we know what the final rule will say."

Ultimately the rule could change the relationship between employers and the participants in the 401(k) plans, says Gail Weiss, president of Gail Weiss & Associates, a Baltimore consultant to financial services firms.

For example, if a fund company has shut out investors for market timing in their private brokerage accounts, but then learns that these investors are participants in their funds through a 401(k) plan, it’s going to tell the employer that those employees have to find another fund.

"The end result of this is that employers are now going to be enforcing fund companies’ policies," Weiss says. Furthermore, the company then has to quickly find a replacement fund for the employee.

"It’s punishing all plan participants for the actions of a few rapid traders," Stone says. "That’s the most unfortunate thing about this whole issue."

Jessica Marquez