Rule 22c-2 and the impact on TPAs, Trust Companies and RIAs October 26, 2006

Rule 22c-2 and the impact

on TPAs, Trust Companies and RIAs

October 26, 2006

Gail Weiss & Associates, Inc.828 South Charles Street

Baltimore, MD 21230(410) 230-2693

http://www.gailweiss.com

828 South Charles Street | Baltimore | MD | 21230 | (410) 230 – 2693 | www.gailweiss.com

2

Agenda

Market Timing Overview

History of the SEC Rule 22c-2

Industry Response

Practical Concerns

Questions and Answers


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Market Timing Defined

Refers to the practice of buying and selling mutual fund shares over the short term to exploit potential pricing inefficiencies

Usually market timing is contrary tothe stated policies of a mutual fund set forth in the prospectus

Not illegal


4

Market Timing Impact

Market timing is detrimental because:

Incurs additional trading costs

Loss of investment opportunity

Shareholder dilution

Tax consequences


5

Market Timing Concerns

Market timing can be done with orwithout the consent of the mutual fund

Industry standard trading practices have made market timing difficult and in some cases impossible to detect


6

Market Timing Reform

SEC Rule 22c-2 History

Proposed Rule March 5, 2004

Final Rule March 11, 2005

Proposed Amendments

March 3, 2006

Effective Date October 16, 2006


7

Market Timing Reform

Consistent themes: Protecting the long-term investor from

market timers

Trading transparency


8

Proposed Rule 22c-2

Mandatory 2% Short-Term Redemption Fee for shares purchased within the previous five business days

Fee to be retained by the fund


9

Proposed Rule 22c-2

Exceptions: Money Market Funds

Exchange Traded Funds (ETFs)

Funds that adopt a policy to permit short-term trading and disclose this policy in the prospectus with comments about the potential additional costs to the fund


10

Proposed Rule 22c-2

Operational Considerations: Funds are not precluded from

instituting a longer holding period

Fee determined using the “First in, first out” or FIFO method

De minimis provision permits funds the discretion to forego the assessment of redemption fees if the redemption proceeds are $2,500 or less


11

Proposed Rule 22c-2

Operational Considerations continued:

Mandatory fee waivers for unanticipated financial emergencies on redemptions of $10,000 or less upon written request

Funds have the discretion to waive the fee on financial emergency transactions in excess of $10,000


12

Proposed Rule 22c-2

Investor Transparency Alternatives: Intermediary account number must be

included with each transaction; or

Intermediary agrees in writing to identify redemptions that are subject to redemption fees and transmit sufficient information to the fund to allow the fund to assess the redemption fee; or

Intermediary agrees in writing to impose redemption fee and remit the proceeds to the fund.


13

Proposed Rule 22c-2

Investor Transparency Required Reporting:

Tax Identification Numbers

Amounts and dates of all purchases, redemptions and exchanges within an omnibus account

Weekly or more frequent basis


14

Final Rule 22c-2

Voluntary redemption fee not to exceed 2% for shares purchased within the previous seven calendar days

Redemption fees must be determined by each fund board of directors including a majority of independent directors

Fee to be retained by the fund

Written agreements are required with all “financial intermediaries” regarding information sharing and responsibility to restrict or prohibit trading under certain circumstances

Money market and ETFs are excluded


15

Final Rule 22c-2

Written agreement requirement: With each financial intermediary regardless of

whether a redemption fee is imposed

Includes requirement that the financial intermediary must provide upon request information about the identity of shareholders and their transactions in fund shares

Contains provision requiring the financial intermediary to restrict or prohibit further purchases or exchanges of a specified shareholder as identified by the fund


16

Final Rule 22c-2

Financial Intermediaries Defined: Broker, dealer or any other entity that holds

securities in nominee name; and

Insurance companies that sponsors a registered separate account organized as a unit investment trust, master-feeder funds and certain fund of fund arrangements not specifically excepted from the rule; and

In the case of an employee benefit plan, the plan administrator or plan record keeper


17

Final Rule 22c-2

Concerns with the final Rule 22c-2: Redemption fees will vary greatly

Amount assessed

Time period

Accounting method

Obtaining agreements with each “financial intermediary” will be a significant burden for both the funds and firms

Data reporting requests will vary greatly

Restricting or prohibiting future purchases will be a technological challenge for some


18

Final Rule 22c-2

Consequences for noncompliance: Funds are prohibited from redeeming shares

within seven days


19

Proposed Amendments

Limit the types of intermediaries with which funds must negotiate written agreements

Address situations when there are chains of intermediaries

Clarify the effect of a fund’s failure to obtain agreements with any of its intermediaries


20

Proposed Amendments

Proposed Small Intermediaries Exclusion: Excludes any intermediary that the fund treats

as an individual investor for purposes of the fund’s policies intended to eliminate or reduce the dilution of the value of fund shares

Concern that many small retirement plans covering only a few employees would be deemed a “financial intermediary”


21

Proposed Amendments

Proposed Intermediary Chain Exclusion: Limits the requirement of the funds to obtain

written agreements with only the first-tier intermediary that trades directly with the fund, its principal underwriter or transfer agent or a registered clearing agency

Concern that many intermediaries are actually holding shares on behalf of other another intermediaries and the underlying transaction data and investor identification was not readily available


22

Proposed Amendments

Proposed “Shareholder Information Agreements” must include an obligation to: Provide, promptly upon the fund’s request,

identification and transaction information for any shareholder accounts held directly with the first-tier intermediary

Use its best efforts to obtain and forward or have forwarded the information from underlying intermediaries

Prohibit future purchases due to failure to remit the requested data


23

Proposed Amendments

Proposed change to the effect of lacking an agreement: Initially the lack of an agreement meant an

intermediary would be precluded from redeeming the shares within seven days of purchase

Proposed change to revise the rule so that if a fund does not have an agreement with a particular intermediary, the fund must prohibit future purchases


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Industry Response

Variety of working groups have formed including representatives of: American Bankers Association (ABA)

American Society of Pension Professionals and Actuaries (ASPPA)

Depository Trust & Clearing Corporation (DTCC)

Investment Company Institute (ICI)

Securities Industry Association (SIA)

Society of Professional Administrators and Record keepers (SPARK)


25

Industry Response

ICI’s Standardized Data Reporting Working Group: Guidelines Taskforce

Technical Design Taskforce

Communications Taskforce


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Guidelines Taskforce

Definitions

Best Practices

Examples


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Significant Definitions: First-tier and underlying intermediary

Participant/Shareholder

Omnibus Accounts

Transaction Categories


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Intermediaries defined: First Tier – an intermediary that has an

existing contractual relationship with the fund to act as a conduit for executing transactions

Underlying – a related entity that transacts with the funds through services provided by a first-tier intermediary


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Participant/Shareholder defined: Individual investors including participants in

retirement plans or shareholders in an omnibus account.

Participants/Shareholders are usually identified by SSN or TIN to the extent they are available.


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Omnibus Account Defined: Represents assets for multiple investors and

usually registered in the name of the intermediary Plan Account – one account for single retirement

plan with multiple participants

Investor Omnibus Account – one account for multiple retail accounts, IRAs, etc.

Super Omnibus Account – includes assets of more than one omnibus account


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Transaction categories: Category 1– actively directed by investor or

their agent with sufficient control to perform market timing activities

Purchases and redemptions

Fund Transfers, exchanges, rebalancing

Non-participant directed transactions if the participant receives the benefit

Category 2 – transactions that are considered systematic or non-directed

Periodically scheduled purchases or redemptions

Payroll deductions, loan repayments, earnings


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Best Practices: Typical Request:

Date range not to exceed 90 days

Limited to previous year

Acknowledgement within one business day

Data provided within three business days from first tier intermediary and five days with underlying intermediaries


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Processing Flow

Critical Data Elements

Data Definitions

Common Terms

Record Layouts


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Processing Flow: Day One – Fund initiates request

Day Two – Intermediary confirms receipt

Day Three – Intermediary responds

Day Four – Fund analyzes the data

Day Five – Fund requests additional information with respect to super omnibus accounts and the process starts all over again


35


SDR Summary and Detail Data Requests

Summary Request Review Detailed Request

NS

CC

1st T

ier I

nter

med

iary

2nd T

ier I

nter

med

iary

Fund

Request Summary data on Omnibus

accounts

Process F40 request from

fund

Process ppt level data

request from funds

Process F40 Request

Process B43 responses

Respond via B43

w/in 1-3 business

days

Provide participant level data

clearing 1st tier

intermediary

Ppt level data maintained

Respond via B42 w/in 1-3

business days

Request data on Omnibus accoutns

Process F40 Request

Process F40 request from

fund

Process B42 responses

Sum

mar

y S

DR

Req

uest

Fund to analyze summary data to determine if additional

information is required from intermediary

No:

Inte

rmed

iary

requ

est

dat

a fro

m u

nder

lyin

g in

term

edia

ry

Yes

1

2

1: Agreements to be established between funds and 1st tier financial intermediaries for omnibus relationships.

2: 2nd tier financial intermediaries will enter into agreements with 1st tier intermediaries or directly with funds. Structure and agreements to be negotiated by and between 1st tier intermediaries and funds.


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Critical Data Elements: CUSIP

Fund Account Number

Plan Identifier/Omnibus Account Number

SSN/TIN or other identifier

From/to Dates

Transaction amounts with Type and Category

Threshold Amount

Rep ID, branch and firm


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Additional information regarding: Data Definitions

Common Terms

Record layouts

Can be found in the handouts


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Communications Taskforce

Model Language Agreement to provide information

Period covered by the request

Form and timing of response

Agreement to restrict trading

Sample Communication Package


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Practical Concerns

How will Rule 22c-2 impact my business?

What do I need to do from a legal agreements perspective?

What do I need to do from an operational perspective?

Do I need to change any of my policies and procedures?


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Practical Concerns

Evaluate Exposure Identify each mutual fund that is in a client

account

Understand the market timing rules for each mutual fund

Determine how each mutual fund is traded


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Practical Concerns

Evaluate need for Shareholder Information Agreements If you trade directly with funds, you

need to get an agreement

If you trade through an intermediary, you need to confirm that the chain of intermediaries in which you participate has executed all necessary documents

If you trade through an intermediary, you need to sign a agreement with each intermediary


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Practical Concerns

Evaluate required technology enhancements A placeholder for SSN/TINs

Trade tracking to access applicable redemption fees

Indicator to restrict future trades at the investor level

Responding to data requests in a secure manner

Processing turnaround times


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Practical Concerns

Evaluate the compatibility of your legal agreements’ obligations with your technological capabilities


44

Practical Concerns

Privacy concerns vs. contractual obligations Applicable federal and state privacy laws

permit the disclosure of confidential customer information if the disclosure is necessary to comply with applicable legal requirements.

Privacy policies as stated may have to be amended.

Contracts between intermediaries, participant record keepers and plan sponsors may have to be amended.


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Practical Concerns

Evaluate impact on policies and procedures Adding a new fund

Executing rebalance/reallocation routines

Fulfilling client request for cash

Processing turnaround times


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Practical Concerns

Gotchas Executing redemptions to pay fees

Managing client expectations with respect to requests for cash

Corrections processing

Trading restriction applied to investor due to trading activity at another institution and now you must also restrict that investor

Staff unwittingly responds to data request in an unsecured manner (i.e. email)


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Conclusion

Reforms have been deemed necessary

All parties involved in mutual fund trading will be impacted

The next steps are unfolding quickly

Be proactive


48

Conclusion

Questions

Documents

Rule 22c-2 and the impact on TPAs, Trust Companies and RIAs October 26, 2006