All too often, "securities regulation" is a form of closing the barn door after the horses are gone.
Regulators are finally closing the door on most of the issues that led to the rapid-trading mutual fund scandals of 2003, and making it so that the horse thieves can't get in to revisit their crimes. Ultimately, the move could lead to sweeping changes but, for now, it's good enough to know that the industry appears to have finally closed the loopholes that led to all the trouble.
This too-late solution comes in the form of Securities and Exchange Commission Rule 22c-2, which officially comes to life next Monday, although an extension has been granted to give management firms six months extra to come into compliance.
The idea of the new regulation is simple: Equal treatment for all shareholders and equal exposure, so that anyone breaking the rules does it in broad daylight.
It starts with forcing fund managers to come up with policies for redemption fees and market-timing, and to then apply those rules across the board.
Redemption fees are designed to discourage quick turnarounds. Unlike a sales charge or the fund's expense ratio, a redemption fee is paid to the fund and not to management, and is designed to reimburse the other shareholders for the trading costs that come up when someone makes a fast round-trip.
Many firms installed redemption fees immediately after the scandals hit the news, but have since backed down or refined the charges, so that they don't restrict ordinary folks who make reasonable moves rather than a lot of timing trades.
By itself, market timing is not illegal; the problem was that the funds ignored rules against quick in-outs, allowing some shareholders special treatment. The new rule stops that behavior.
It does that by cracking the information seal on "omnibus accounts," retirement or brokerage accounts where daily trades for many shareholders are aggregated. Think of it like your retirement plan, where every day the purchases and sales are lumped together and then executed as one.
An omnibus account creates the problem that a fund company doesn't know its customers. Shareholders seeing their holdings grow or shrink may think they have a relationship with the fund company, but management knows only that it has, say, 1,000 accounts from the XYZ Corp. retirement plan. It can't tell which of those shareholders are trading like crazy, and which ones are playing buy-and-hold because only the plan administrator gets that information.
As a result, fund firms couldn't isolate out the bad guys. Even if management could tell someone was gaming the system - and the big settlements with regulators were made because they could - they didn't know who was wearing the black hat. Likewise, it couldn't figure out who - if anyone - in the omnibus account had crossed the trading lines and owed a redemption fee.
Under 22c-2, however, that changes. The firms that do administration for omnibus accounts must be able to give management enough information so that fund companies can better monitor trading in their funds and enforce those redemption fees.
"The idea is to make sure that no one gets preferential treatment," says Christine Gill, senior director at PFPC, one of the big fund-servicing firms. " ... This should stop it from happening again, and the only ones who will notice something different are the market timers."
Even as the rule comes into being, there is still no consensus on exactly how fund firms will handle the information, in part because a typical fund company could be dealing with anywhere from a few dozen to a few hundred different administrative firms. What is unlikely, at this point, is that fund firms will wind up with the personal data of shareholders heretofore buried in those omnibus accounts.
Instead, it appears that they will be looking at anomalies in trading patterns, which raise a red flag and then allow them to get the specific details.
Consumers worried about any sort of privacy breach - or about suddenly getting a slew of mail directly from the fund firms they invest with in the 401(k) plan - can rest easy. Fund companies are barred from using an investor's name, address, tax identification number or account number gleaned from the omnibus account data for any purpose other than to check for trading abnormalities.
The cost of getting all of this information - and the resulting additional safety from rapid trading - has been pegged by several consultants at something north of $150 million annually, a price ultimately passed on to shareholders.
Charles Jaffe writes for MarketWatch. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.