March 6, 2004
I would like to address a few specific points in the proposed legislation being considered to address the market timing/late trading issues that have been so prevalant in the press of late. First, the adoption of a 2 percent fee should be a significant deterrent to such activities however, a flat fee may not be the most appropriate structure. As balances increase, there is clearly a lower cost associated with conversion of shares both in and out of a fund. For example, consideration should be given to evaluating what the true cost of a round trip purchase of specific shares would be within a fund. With the bid ask spreads being significantly lower than they have been historically, that cost may be considerably lower than the 2 percent fee being contemplated for larger transactions. While I agree that there should be a deterrent, to make it onerous is a mistake. You are essentially penalizing individuals that have the expertise to properly manage their portfolios. It is clear that there is a need to eliminate the damage done by day traders as excessive costs, or obvious arbitrage opportunities do cut into the long term shareholders returns. It may be more beneficial to leave it up to the individual fund managers and/or families to determine the proper fee, depending upon the type of instruments that comprise each underlying fund. Clearly, the more liquid the stock, the less cost associated with a round trip trade. Finally, the fee should clearly be enough to compensate for any loss to the remaining shareholders but should not be much greater. It is of course assumed that the 2 percent fee would become a part of the income stream of the underlying fund and would not run to the general profits of the fund managers themselves. I think you need to be cautious so as not to create a boon to fund managers when the intent is that the fee reimburse other shareholders for costs incurred by rapid traders.
With regard to the rapid trader definition, I do not believe that 5 days is a realistic period for all funds. Five days ties the hands of individuals who closely manage their portfolios. I would assume that most rapid traders are attempting to capitalize on news that would affect the next days trade. A restriction of as little as 2-3 days should be sufficient to deter those who would attempt to swoop in and arbitrage the timing of information and the differences in when markets are open. My reference to 2-3 days would be for domestic funds that are comprised of highly liquid exchange traded securities. There is little opportunity to arbitrage information when you can only buy a fund at the closing price on the day you make the trade. A 4:01 trade gets you the next days closing price. In this instance, market timers are actually employing pure investment strategies buy rotating out of varying funds based on style, composition, etc. With regard to less liquid funds or those that hold securities that are traded in markets that close at differing time periods, there is clearly a need to have a longer holding period although one or two extra days should be sufficient. To ensure that this is effective, the SEC should require all fund managers to estimate the change in prices associated with shares traded on closed exchanges that could be affected by news that becomes known when the domestic markets are open to say 4:00PM. That would reduce and/or eliminate the arbitrage that has been appparent in some international or high yield funds. In this manner, an accrual to reflect the expected change in value post foreign market close but up to domestic market close would shut down this window, particularly when the accrual could, in some cases, result in an overvaluation at a given domestic close time which would be to the detriment of the short term, one day trader only, and have no effect on longer term holders.
Finally, I think it is important to differentiate between accounts that are internal such as 401Ks vs other types of accounts because the costs associated with internal transfers are considerably less than other types of trades where commissions and/or 12b1 fees may be involved. These internal transers, most of which are done over the internet, have little marginal cost and in most instances, funds have sufficient liquidity to absorb the transaction which means that the total trade costs pennies. A 2 percent fee in this instance is clearly excessive as there is little impact from this activity on the other sharelholders. My 401K plan is capitive in one family and I am forced to keep all of my investments in one of their funds. It seems to me that in those instances, the technology should be able to provide the fund managers with the information they need to balance their portfolios before the close of any given business day and therefore should not predjudice any shareholders. I would think that because the funds are capitive within the family, that these retirement plans could also adopt a shared liquidity facility to obviate the need for excessive purchases and sales since the money is not going outside the fund managers domain. That is just a thought, but it seems to me that the liquidity needs for captive plans can be managed a bit differently which would keep costs associated with transfers between accounts at close to nil.
My overall concern as should be evident from my comments is that you unduly penalize those of us who closely manage their retirement investments in your efforts to weed out abusive practices.
Thanks for considering my comments. If you want more, I am sure I can give it more thought.