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Retirement Industry Criticizes Controversial Hard Close, Late Processing Proposal

Regulatory Agencies

On Tuesday, the Securities and Exchange Commission (SEC) closed the comment period for its controversial late-processing proposed rule to combat an issue first raised nearly 20 years ago. 

The proposal would require open-end funds to use “swing pricing,” the method to allocate costs from inflows or outflows to the investors engaged in that activity, rather than diluting other shareholders. The proposal would also require a daily 4 p.m. ET “hard close” for relevant funds.

Several retirement plan and financial services advocacy organizations submitted comment letters with concerns, citing cost and logistics they say would ultimately harm plan participants. 

“The ARA has serious concerns about the Hard Close and its impact on DC Plans and participants,” American Retirement Association CEO Brian Graff and General Counsel Allison Wielobob wrote in its letter to SEC Chair Gary Gensler. 

Not only would mandating a Hard Close require a complete overhaul of intermediaries’ systems and processes, vastly increasing costs to participants, “it would create inequities among investors in open-end fund and eventually, increased flows of investor money into less regulated vehicles and potentially, a push for many asset managers to create alternative funds instead,” they added.

Arguing that the Hard Close would create a two-tiered system for open-end fund investors and DC Plan investors would be disadvantaged, retirement savings rates would also suffer. 

“The ARA agrees with the Commission that if there are significant inequities in the allocation of the transaction costs of mutual fund trading activity that remedying such inequities is a laudable goal,” the letter conceded. “However, any potential solution must not disadvantage or harm the millions of American families who own mutual funds through their employer-sponsored defined contribution plans or create significant collateral damage.”

The 2003 proposal received significant pushback for the potential harm to plan participants, and the SEC admitted that a hard close would require substantial processing changes.

The reintroduced proposal is part of a larger effort to better regulate liquidity risk, especially in times of market stress, with SEC Chair Gary Gensler pointing to problems with redemptions at the onset of the COVID-19 pandemic. 

The SEC argued a 4:00 p.m. hard close would improve order processing and help to operationalize swing pricing, which allows managers to adjust the NAV when securities’ inflows or outflows exceed a predetermined threshold. The Brookings Institution explained that the fund could then pass along the associated trading costs to those making the trades to better protect remaining shareholders from dilution.

Fellow Travelers

ARA joined a number of other industry advocacy and research organizations in opposition to the proposed rule. 

“We respectfully question whether any Investor protection purposes would be served by mandating swing pricing and operationalizing it by means of a 4 p.m. ET hard close,” Insured Retirement Institute (IRI) Director of Federal Regulatory Affairs Emily Micale wrote. 

“The Proposal inappropriately discounts or overlooks a number of concerns that would confront the nation’s retirement system under a hard close environment,” Groom Law Group argued, adding, “the costs, disruptions and hardships to retirement savers under the Proposed Rule’s hard close requirement would be severe and far reaching.”

“We urge the SEC to abandon the Proposal’s swing pricing/hard close framework entirely,” the American Council of Life Insurers (ACLI) said. “If adopted, hard close would impose substantial harms on American investors.”

The US Chamber of Commerce said the proposal should be withdrawn “because of the lack of an appropriate cost-benefit analysis and the proposal also fails to meet the tripartite mission of the Commission to facilitate investor protection, capital formation, and competition.”

“[I]n ERIC’s view, applying a hard close requirement to transactions involving retirement plans is inappropriate,” the ERISA Industry Committee (ERIC) wrote.

Finally, the SPARK Institute’s Tim Rouse “strongly urged the Commission not to adopt the proposed hard close requirement.”

In 2003 and 2004, the SEC and former New York state Attorney General Eliot Spitzer investigated allegations against dozens of banks and mutual fund companies that they favored large institutional investors over ordinary long-term shareholders.  

The Washington Post reported that many admitted to after-hour trading deals with specific customers, with some executives profiting at smaller investors’ expense. The firms also made short-term trades that exploited timing differences, contradicting language in fund prospectuses that supposedly discouraged the practice.