IDA conference update: U.S. regulators overreacting to fund scandals, says MFS chair

(June 14, 2004) U.S. regulators are going too far in their response to a series of mutual fund scandals, proposing new rules that are both overly prescriptive and costly, says a senior fund industry executive.

Robert Pozen, appointed chair of Boston-based MFS Investment Management earlier this year, spoke Monday morning at the IDA’s annual conference in Mont Tremblant, Quebec. “I think it’s fair to say we are in the midst of an overreaction,” he said.

The scandals, — which have affected a number of major American fund companies — mostly involve late trading and market timing.

There’s pressure in the U.S. for a “hard” 4 p.m. close, says Pozen, prohibiting all fund trading after that time. But the current structure makes that problematic, he explained, noting that many of the big American brokerages use omnibus accounts, gathering all the day’s orders together and putting through a large net or batch order. That order often doesn’t get to the fund companies until 4:30 p.m. or 5 p.m.

“A hard close at 4 p.m. means that many traders will have to have their orders in by 3 p.m. or even 2 p.m., and they don’t want to miss that last hour of trading,” said Pozen.

Instead, Pozen suggests a “smart” close, under which trades would have to be time-stamped and certified by qualified intermediaries by a 4 p.m. deadline. The batch orders would then be sent on to the fund distributor or transfer agent by 5 p.m.

“There would have to be surprise audits by regulators to make sure the time stamps are accurate but I think this approach makes a lot of sense,” said Pozen. “It’s a practical solution to a difficult problem.”

Market timing, which is not illegal, is an even stickier issue for the fund industry. The U.S. Securities and Exchange Commission (SEC) has proposed implementing a mandatory 2% fee on all trades that are bought and then sold within five days.

But Pozen says he’s concerned the five-day period will capture legitimate traders, such as pension funds. A more intelligent solution, he believes, is to shorten the time period and impose a series of exemptions.

Requiring the registration of hedge funds would also help combat market timing, he adds. “We don’t know what they are doing, but they are getting bigger every year and constitute a huge amount of trading volume,” noted Pozen. “If you don’t touch hedge funds, you’ll have a huge amount of short-term trading and anything else really won’t make much impact.”

Overall, it’s been a tough time for the U.S. fund industry, Pozen acknowledged, and it’s not over. “I predict there will be a lot more cases [of abuse]. The good news is there will be no new legislation by Congress, but the SEC will come with a lot of new rules.”

These developments will inevitably spill over to Canada, Pozen predicted, considering how closely the two markets are linked. “You’ve got to have market timing and late trading investigations here and you’ve got to be looking at redemption fees. Hopefully, Canada will make some more intelligent decisions that the ones that are being made in the United States.”

The IDA annual conference continues through Tuesday.

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com