May 10, 2004
I am writing to express my adamant opposition to the adoption of proposed new Rule 22c-2 under the Investment Company Act, which would require nearly all mutual funds to impose a two percent fee on the redemption of shares purchased within the previous five days.
The basic premise for this proposed rule seems to be that the costs associated with frequent trading of mutual fund shares outweigh the costs associated with the imposition of a redemption fee in all cases and in a uniform way. This premise oversimplifies and ignores the huge variety of specific facts and circumstances that exist in the mutual fund marketplace. While it is true that successful i.e. profitable short term trading in mutual fund shares can capture returns that would otherwise accrue to longer term shareholders, the inverse is equally true - unsuccessful short term trading can actually benefit long term shareholders. Ultimately, these effects can be boiled down to the simple axiom that shareholders suffer to the extent that cash is held when the value of the funds portfolio is rising, and benefit to the extent that cash is held as the value of the portfolio falls. The risks associated with short term cash flows should be fully considered by investment advisers in managing fund portfolios, and by boards of directors in formulating policies for specific funds.
Investment strategies employed by some funds may make them particularly attractive targets for short term trading, and there are certainly cases where a funds strategy is likely to be adversely affected by cash flows associated with frequent trading in fund shares. When these risks are significant, they should be clearly disclosed to potential investors, and fund boards should carefully evaluate the costs and benefits of employing measures such as redemption fees to protect the interests of all shareholders. Once appropriate polices are established by a fund, they should be disclosed, adhered to, and administered consistently. And importantly, when funds fail to adhere to their own policies or apply them selectively, the SEC and/or others with jurisdiction in such matters should act to ensure that the laws are enforced.
Proposed rule 22c-2 imposes a one-size-fits-all solution to a set of issues that is far too varied and complex even to be described as a single problem. The scandals which precipitated this proposal did not result from a lack of adequate rules. These scandals resulted from decisions by specific individuals to breach their fiduciary responsibilities and to violate their own funds policies, actions which are most certainly prohibited under existing rules. If these scandals exposed a need for any additional rule-making, it would be in the area of disclosure along the lines of the recently adopted amendments to Form N-1A requiring funds to disclose in their prospectuses both the risks to shareholders of frequent purchases and redemptions of investment company shares, and the funds policies and procedures with respect to such frequent purchases and redemptions.
Adoption of rule 22c-2 would harm the interests of all fund shareholders in that all funds would incur costs associated with their own compliance, and would be forced to share in the industry-wide costs of implementation of the rule. Many funds have made perfectly reasonable decisions that the costs of adopting and administering redemption fees outweigh the benefits to their shareholders, while others may have equally reasonably concluded to implement redemption fees of various amounts to be applied in ways that are particular to their own circumstances. The proposed rule would set aside and ignore all of the reasoned judgment that any funds board may have applied to evaluating the risks and determining its own policies with respect to the frequent trading of fund shares.
The primary result of adopting this rule would be that an enormous amount of shareholders money would be spent to implement a policy that has, in many cases, been explicitly considered and rejected by their own boards. The second inevitable effect of this rule would be a dedication of marketplace resources to identifying opportunities to profit from trading mutual fund shares over a six-day timeframe or to net more than two percent in less than five days. When the next opportunity arises to profit from frequent trading of mutual fund shares, this new rule will be no more effective in preventing it from being exploited than any existing rule would be or has been.
Finally, the SEC should be fully aware that the support for this proposed rule by the Investment Company Institute does not reflect the views of many of its members, particularly those of many smaller funds upon whom the burden of compliance with this and other recently proposed and adopted rules will fall most heavily.