[16854]
December 9, 2003
TO: BOARD OF GOVERNORS No. 70-03
RE: ADDITIONAL POLICY MATTERS FOR BOARD CONSIDERATION
In addition to the Board’s consideration of the ICI’s policy on soft dollars and brokerage
for sales, there are three additional matters that the ICI staff believes the Board should consider
at its December 12th meeting. Each has been raised, in some form, in proposed legislation. The
three matters are: (1) limiting short-term trading in fund shares by fund insiders, (2) requiring
fund portfolio managers and officers to disclose their holdings in fund shares, and (3) directing
the SEC to adopt rules on potential conflicts of interest that can arise when the same firm
manages both mutual funds and hedge funds.
Each of these matters is discussed below.
Short-term Trading in Fund Shares
Allegations of insider trading in fund shares have led to calls for restrictions on short-
term trading by fund insiders. In its settlement with the SEC, Putnam agreed to impose a 90
day holding period on all fund investments by employees of the fund’s adviser. Investment
personnel would be subject to a one-year holding period. H.R. 2420 would make it unlawful for
any director or employee of a fund (or a fund’s adviser, underwriter, or affiliate) to engage in
“short-term transactions” (to be defined by the SEC) in securities issued by the fund, or any
affiliate of the fund. The Corzine-Dodd bill contains an identical provision, as does legislation
introduced by Senator Kerry. (The Corzine-Dodd bill also contains a provision requiring
“senior executive officers” to hold fund shares for at least six months.)
The ICI’s best practices on personal investing require disgorgement of profits on
purchases and sales of securities within 60 days. However, the best practices do not apply to
investment company shares. In October, the ICI recommended that funds amend their codes of
ethics to include transactions in fund shares.
I believe that the ICI should call for statutory or regulatory action that would impose
restrictions on short-term trading by certain fund insiders. The recent allegations involving this
type of trading by portfolio managers and others have, perhaps more than any other revelation,
discredited mutual funds in the eyes of many. In particular, I would recommend that (1) the
restrictions apply to all fund “access persons”, as defined under SEC rules, (2) they require
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disgorgement of profits realized from transactions that occur within a specified period (e.g., 60
days), and (3) they permit the SEC to grant exceptions by rule or order (e.g., to make
appropriate allowances for employees who engage in systematic investment plans).
Disclosure of Fund Holdings
The allegations of insider trading noted above have also led to calls for increased
disclosure of fund holdings by certain fund insiders. Most of the bills pending in Congress
would require portfolio managers to disclose their holdings in the funds they manage. The
Corzine-Dodd bill also would require senior executive officers to make public disclosure of
their intention to purchase or sell fund shares prior to the transaction.
I believe that the ICI should respond by endorsing requiring disclosure of fund holdings
by both portfolio managers and fund officers. Such disclosure could parallel that required of
fund directors, which requires disclosure within dollar ranges, rather than an exact amount.
Joint Management of Mutual Funds and Other Accounts
Both H.R. 2420 and the Corzine-Dodd bill would ban the same individual from
managing a mutual fund and a hedge fund. While this would not prohibit joint management of
a mutual fund and a hedge fund by the same investment advisory firm, some have called for
broadening the provision in this manner. In addition, even as presently written, the provision
could be troublesome for smaller fund advisers and subadvisers to registered funds that also
manage hedge funds.
I believe that, in lieu of this type of flat prohibition, the ICI should call for the SEC to
adopt rules that would govern potential conflicts involved in the side-by-side management of
mutual funds and unregistered funds. These rules could require advisers to such funds to have
policies and procedures in place to address specified issues, such as trade allocation, short sales,
and sequential transactions. In addition, mutual fund boards could be required to review such
policies and procedures, and to receive reports on them from the fund’s compliance officer. I
believe that rules along these lines would be more effective at addressing potential conflicts,
and would avoid the hardships noted above.
Matthew P. Fink
President