Heritage Foundation Leadership for America

Background:  On December 17, the Securities and Exchange Commission proposed amendments to the rules governing the pricing of mutual fund shares. The SEC regulations would allow an order for mutual fund shares to receive that day’s pricing only if the order is received by the mutual fund (or its transfer or clearing agent) before the 4 p.m. EST deadline for pricing mutual fund shares.

The SEC also sought comments on an alternative approach that would allow financial intermediaries to submit orders after the 4 pm deadline only if the intermediary has the ability to unalterably time stamp the order, annually certifies that it has the ability to prevent late trades, and submits its controls to an annual audit by an independent public accountant. 

Status:  The proposed amendments to rules governing pricing of mutual fund shares are open for public comment until February 6, 2004.                         

Discussion: This proposal is one of the results of recent disclosures that select favored customers were allowed to purchase mutual fund shares well after the supposed 4 pm deadline. Since mutual fund shares are currently only priced once a day at 4 p.m. EST, these after hours trades allow purchasers to take advantage of late market developments such as earnings announcements that will alter the value of these shares at the next pricing.

Ironically, in the name of preventing abuses by the larger customers, the SEC would end up harming the smaller ones. Roughly 80 percent of mutual fund customers – including most small customers – trade through intermediaries. In order to have their orders received by the mutual fund before 4 pm, those intermediaries would have to establish deadlines well in advance of that hour. Small customers placing orders after that deadline but before 4 p.m. would receive the next day’s pricing. 

The after hours abuses are more a problem of compliance than they are proof of the need for stricter rules. In the long run, once-a-day pricing should be scrapped in favor of pricing mutual funds in much the same as the way that individual stocks and bonds are priced.  

Action item: The SEC’s proposed rule should not be approved. Instead, the SEC should focus on improving compliance procedures. 

This brief was prepared by Heritage Research Fellow David C. John.

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