Fund Trading Cutoff Assailed

Financial services providers stepped up their opposition Wednesday to a proposed strict 4 p.m. Eastern time deadline for mutual fund trade orders, saying the cutoff would be tough on retirement plan administrators and unfair to West Coast investors.

A “hard” 4 p.m. deadline for fund transaction processing is among the reforms the Securities and Exchange Commission is considering in its efforts to eradicate illegal late trading -- one of the abuses that touched off an industry scandal 11 months ago.

A group of more than 50 administrators of 401(k) retirement plans said Wednesday that it had pitched an alternative plan to the SEC, one that would provide more time for fund orders to be processed each day while still ensuring that investors submit their orders by the normal market closing.

This alternative would let intermediaries such as 401(k) record keepers submit purchases and redemptions to fund firms after 4 p.m., as long as those orders were based on instructions received from plan investors before 4 p.m. -- and as long as the intermediaries had adopted measures to prevent abuses with controls such as time-stamping software and independent audits of transaction activity.

A strict 4 p.m. deadline would add costs and disadvantage 401(k) investors, the institute said in a letter to the SEC.

“The hard cutoff relegates 401(k) participants to second-class status, and in reality it doesn’t solve the problem,” said Jeff Close, spokesman for the Spark Institute in Simsbury, Conn., an arm of the Society of Professional Administrators and Record Keepers, the group behind the alternative plan.

Mutual fund companies have long allowed brokerages and 401(k) plans to submit buy and sell orders after the 4 p.m. market closing -- for pricing at that day’s final value -- as long as the intermediaries indicated that the orders had been received from their investors by 4 p.m.

The extra time is necessary to process and record transactions, many intermediaries contend.

But New York Atty. Gen. Eliot Spitzer found last year that some investors were submitting orders for funds after 4 p.m. while still getting that day’s closing price. The investors had sought to exploit unfolding trends in foreign markets that could affect U.S. fund prices the next day.

Spitzer likened the practice to betting on a horse race after it was over.

To end the potential for late trading, some analysts say, the financial industry should slam the order window closed at 4 p.m., which would mean 1 p.m. for West Coast investors, brokerages and retirement plans.

Because the hard 4 p.m. deadline would require that all orders be delivered to fund firms by that time, third parties that consolidate trades on behalf of 401(k) investors or that run online fund trading supermarkets say they would have to impose earlier cutoffs on investors to provide time for processing.

That would put their customers at a disadvantage to investors who choose to deal directly with fund companies to trade, the intermediaries say.

West Coast investors would face an extra hardship because they already must submit orders earlier in the day, opponents of the hard-deadline proposal say.

“Already on the West Coast the trading deadline is 1 p.m.,” said Michael Townsend, Charles Schwab Corp.’s vice president for public policy. “Under the ‘hard 4’ proposal, the cutoff for retail investors in the West might be backed up to 11 a.m., and in the retirement context, you’re talking breakfast” in terms of when orders might have to be submitted by investors to get that day’s closing price.

Schwab, 401(k) administrator Hewitt Associates and other firms are finalizing a plan dubbed “Smart 4,” which they say is similar to the Spark Institute’s plan. It could be sent to the SEC by next week, Townsend said.

Frank McArdle, head of Hewitt’s Washington office, said a hard cutoff also would give an unfair edge to large fund companies that are so-called bundled providers -- meaning those that handle administration of a 401(k) plan as well as provide the investment options.

Plans with bundled service could take investor orders until 4 p.m., McArdle said, whereas administrators using more than one fund firm in their 401(k) plan would need an earlier cutoff to consolidate and relay trades.

Some contend, however, that a hard cutoff would be the fairest solution for all investors.

Mike Scarborough, whose Scarborough Group in Annapolis, Md., manages 6,000 accounts for 401(k) investors, said he didn’t believe that third parties would need earlier investor cutoffs to meet a hard 4 p.m. deadline.

“That’s a scare tactic, if anything,” Scarborough said. “They re-price stocks in a nanosecond. You can’t tell me they can’t figure this out.”

He said record keepers were griping because they would face extra costs in an area that often served as a “loss leader” for other financial services sold to companies, such as money management.

“If you’re going to be in the record-keeping business, you’ve got to do right by your customers, and your customers are not only the corporations but also the employees,” he said.

The SEC is expected to decide on the issue this fall.