©2005 Investment Company Institute. All rights reserved. Information may be abridged and therefore incomplete.
Communications from the Institute do not constitute, and should not be considered a substitute for, legal advice.
[18841]
May 11, 2005
TO: BROKER/DEALER ADVISORY COMMITTEE No. 19-05
BROKER/DEALER ASSOCIATE MEMBERS No. 8-05
COMPLIANCE ADVISORY COMMITTEE No. 38-05
OPERATIONS MEMBERS No. 7-05
PENSION MEMBERS No. 19-05
SEC RULES MEMBERS No. 59-05
SMALL FUNDS MEMBERS No. 42-05
TRANSFER AGENT ADVISORY COMMITTEE No. 21-05
RE: INSTITUTE COMMENT LETTER ON REDEMPTION FEE RULE
Earlier this year, the Securities and Exchange Commission adopted new rule 22c-2 under
the Investment Company Act and requested comment on the rule and related redemption fee
issues.1 The Institute’s comment letter is attached and briefly summarized below.
COMMENTS ON RULE 22C-2 AS ADOPTED
In the letter, the Institute expresses serious concerns that rule 22c-2, as adopted, is
fundamentally flawed. We point out that the Commission has adopted a rule under which
funds singularly bear all of the responsibilities and liabilities associated with imposing
redemption fees. We suggest that the better approach is for regulatory responsibilities to be
appropriately shared by funds and intermediaries, and urge the Commission to carefully
consider whether and how such an approach might be implemented.
The Institute also argues that the requirement under the rule that funds obtain written
contracts with every “intermediary” is completely unworkable and that the Commission
grossly underestimates the challenges, costs and burdens associated with this requirement.2 We
urge the Commission to modify this part of the rule as soon as possible and recommend
1 See Memorandum No. 18647, dated March 18, 2005.
2 By October 16, 2006, every fund subject to rule 22c-2 is required to enter into a written agreement with each of its
financial intermediaries. Under these contracts, intermediaries must agree to: (i) provide the fund with certain
information upon request; and (ii) execute any instructions to restrict or prohibit further purchases or exchanges by
a shareholder who has been identified by the fund as having engaged in transactions that violate the fund’s short-
term trading limits. The term “financial intermediary” is broadly defined under the rule to include, among other
things, any entity that holds shares in nominee name or maintains records for a participant-directed retirement plan.
2
assembling a group of industry representatives to help address the difficult issues that the
contract requirement raises. More specifically, we strongly recommend that the Commission
modify the rule to require a fund to obtain a contract with an intermediary when it determines
that doing so is necessary to address abusive market timing. We recommend that the rule
continue to require any such contract, as well as any other written agreement with an
intermediary that will be in force on or after the rule’s compliance deadline, to include the
provisions required under the rule.
In the letter, the Institute also makes a series of specific recommendations with respect to
the contract requirement. These recommendations include:
• Incorporating a good faith standard into the rule to ensure that funds that make
reasonable efforts to obtain contracts with intermediaries will not violate the
rule if intermediaries refuse to enter into contracts or if, for some other reason,
funds are unable to obtain the required contracts by the compliance deadline;
• Limiting the requirement to obtain a contract only to intermediaries with which
the fund has a direct relationship (thereby addressing the “chain of
intermediaries” problem);
• Clarifying that contracts are required only when necessary to restrict abusive
short-term trading and only for “true” omnibus accounts, where an
intermediary is acting on behalf of multiple investors; and
• Addressing the problems faced by funds underlying insurance company
separate accounts by imposing a direct obligation on separate accounts to apply
funds’ short-term trading limits.3
COMMENTS ON THE COMMISSION’S COST-BENEFIT ANALYSIS
The Institute comments strongly on the Commission’s cost-benefit analysis of the new
rule, arguing that the Commission has grossly failed to meet its obligations to properly assess
the burdens of the contract requirement. The Institute states that this failure, coupled with the
fact that the contract requirement was incorporated into the final rule without the benefit of
industry comment, raises serious questions as to whether the Commission has satisfied its
obligations under the Administrative Procedures Act in adopting rule 22c-2.
In the letter, we argue that it will be considerably more time consuming and expensive
than the Commission has estimated to obtain written agreements with intermediaries and
obtain data from intermediaries. The letter questions the Commission’s estimate of the time
involved in obtaining contracts (4.5 hours per fund), the total cost of that time ($275.99), and the
characterization of the expense as a one-time cost. The letter also argues that the Commission
grossly underestimates, and in some cases overlooks, the costs and technical difficulties in
transmitting data from intermediaries to funds as contemplated by the rule.
3 We suggest that if the Commission is unwilling to take this step, it should at least carefully study this issue to find
an alternative that will assist funds in limiting or eliminating market timing through variable insurance products.
3
COMMENTS ON STANDARDIZATION IN THE REDEMPTION FEE CONTEXT
The Institute responds in the letter to the request for comment on whether the
Commission should establish a set of uniform standards to facilitate the assessment of
redemption fees by intermediaries on shares held through omnibus accounts. Based in part on
recent meetings among the Institute, Securities Industry Association (SIA) and retirement plan
recordkeeping community, we support the use of a “first in, first out” (FIFO) accounting
methodology and the mandatory transfer of share aging histories, and we oppose an exception
for unanticipated financial emergencies. We note that, while not unanimous, the vast majority
of our members support limiting application of redemption fees to “participant-directed
exchanges” in retirement plans.
We strongly urge the Commission to act quickly and definitively on the issue of
standardization. The letter notes that, in the meantime, we will continue to work with the SIA
and the retirement plan community on finding ways to further enhance the effective
implementation of redemption fees and rule 22c-2. These efforts may include working on
model contractual clauses and standard conventions for data transmissions between funds and
intermediaries.
Robert C. Grohowski
Associate Counsel
Attachment (in .pdf format)
Note: Not all recipients receive the attachment. To obtain a copy of the attachment, please visit
our members website (http://members.ici.org) and search for memo 18841, or call the ICI
Library at (202) 326-8304 and request the attachment for memo 18841.