Like the accounting industry before it, the mutual fund industry is going to great lengths to demonstrate the tough love it's willing to dole out in the name of self-regulation.
The Investment Company Institute announced late Thursday its prescription for industry reform, in light of the ever-expanding investigations into a variety of alleged misdeeds by several fund companies, most notably the market-timing issues plaguing
, a unit of
Marsh & McLennan
Strong Capital Management
. The ICI is essentially the lobbying arm for the fund industry and has no regulatory power.
The ICI's suggested reforms are aimed at curbing the most egregious market-timing (a practice that, while technically legal in some instances, can quickly move into criminal territory) and late trading (a form of arbitrage using mutual funds that is explicitly illegal) issues.
First on the agenda is a firm 4 p.m. ET deadline for all mutual fund trades to be reported to mutual fund companies. This measure aims to further discourage illegal late-trading attempts. Late trading occurs when investors are allowed to purchase shares in a mutual fund after the close of trading, but at their 4 p.m. ET close price. (Funds are only valued once a day.) That allows the trader to take advantage of after-market price swings, a practice most commonly used in international funds as foreign companies announce material news at odd hours. (Say
announces some good news after the U.S. markets close. A late trader would purchase shares in a fund likely to benefit from that good news at the market's open.)
An onerous task to be sure, mandating that all trades be registered with the fund company by 4 p.m. ET will require that investors submit their trades sometime around 2 p.m. ET to ensure they're processed the same day. "We recognize that it will affect millions of fund shareholders, thousands of intermediaries and hundreds of fund companies," ICI Chairman Paul Haaga said in announcing ICI's proposal. "The firm 4 p.m. ET deadline represents all that can be done to slam the late-trading window shut."
Secondly, ICI endorses an industrywide, mandatory minimum 2% redemption fee on
mutual funds sold within five days after purchase. The only wholesale exception will be for money market funds. Funds that have the stated strategy of being designed for short-term trading will be able to file with the
Securities and Exchange Commission
for an exemption. "Funds that are illiquid, a valuation challenge or generally lend themselves to arbitrage are certainly able to increase the redemption fee," said Matthew Fink, ICI president. "We were looking for a uniform rule that we could apply to every fund."
And while five days may not seem like a long time to require someone to hold a fund, the very nature of market-timing is such that trades are generally made during one day, Haaga said. The five-day period should be enough to eliminate market-timers without being too onerous for other investors.
Lastly, funds would be required to amend their ethics policies to include oversight of all trading activity among fund executives. ICI stopped short of requiring that managers and other executives actually disclose their trading in the family's funds the way company executives are required to disclose trading in their company's stock. "Managers are often expected to own shares in their funds, and we wouldn't want somebody to sell a big chunk to buy a house and have it seen as a sign," Haaga said. "And the selling of shares due to material nonpublic information
one of the criteria used to determine insider trading is not as big an issue with mutual funds."
The ICI's suggested reforms will be presented in testimony before Congress early next week. The SEC has stated that it will announce its own measures some time in November.