SEC Proposes Standardized Redemption Fees

February 25, 2004

Proposal to require funds to charge 2% redemption fee on shares sold within five days of purchase.

In response to the recent scandals over market timing in mutual funds, the SEC today in a 4-1 vote proposed to require funds to levy a 2% redemption fee on shares sold within five days of purchase.  The proposal will be open to a period of public comment before a second SEC vote on the issue.

The proposal comes in the wake of the furor over 'market timing' in mutual funds, where traders rapidly move in and out of funds to the detriment of long-term investors, who collectively end up footing the tax bill and transaction costs.  Market timers also make the portfolio manager's job more difficult because cash must be kept on hand to accommodate redemptions.

Some fund firms have been accused of publicly discouraging market timing, and then turning around and allowing large accounts to engage in the practice.  Additionally, some fund firms have been accused of allowing time zone arbitrage (late trading) in international funds, again at the expense of long-term investors.  The scandals are damaging to the industry because mutual funds have long been viewed as a level playing field where all shareholders are treated equally.

Although redemption fees may discourage market-timers, some industry experts have pointed out that stale pricing in international funds is fundamental and larger problem that attracts arbitrageurs.

Retail index fund giant Vanguard has taken the lead and charges a 2% redemption fee for some of its international index funds. 

"We charge a 2% redemption fee for short term trading, which in our view is two months round trip," said Gus Sauter, Vanguard's chief investment officer.  "That 2% fee far exceeds any transaction costs we may incur - it's intended to be punitive," said Sauter.  The fee is passed along to all shareholders - it does not go to fund management.

Today's proposal would not apply to exchange-traded funds - which have a defense against late trading abuses since they are continually priced and traded.

"International or domestic, ETF transactions take place on the secondary market between investors - not between investors and the fund," said Lee Kranefuss, head of ETF business at Barclays Global Investors.  "The transactions are taking place on an exchange; investors are not interacting with a fund that may be using stale prices.  The price of an ETF share is updated throughout the day, and is determined by competitive market forces."

Finally, so as not to harm small shareholders, today's proposal allows for funds to waive the fees for redemptions of $2,500 or less. 



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