Recent investigations of mutual fund trading by the SEC and some state  attorneys general have revealed cases of abusive trading practices. The  asset of the plan is the issued security, not any of the assets held by the  investment company. Mutual Fund Trading Abuses Affected Pension Plan Participants but the Extent Is Unclear

The cost to long-term mutual fund investors of late trading and market  timing is unclear, however it does not appear that these trading abuses  affected pension plan participants differently than other long-term  investors. While costs of individual instances of late trading and market  timing may not have a noticeable effect on the value of fund shares held by  long-term investors, the cumulative effect of abusive trading may have  been significant. Ultimately, the effect of late trading and market timing on the savings of  retirement plan participants and other long-term fund shareholders is a  function of which funds they invested in and for how long. Among 34 brokerage  firms surveyed by SEC, including some of the largest in the nation, more  than 25 percent reported instances of illegal late trading at their firms. Market timing can also be difficult to identify because, among other  reasons, the omnibus accounts of intermediaries obscure individual  account transactions. Regulators Are Taking Actions to Address Abusive Mutual Fund Trading

SEC and DOL have each taken steps to address abusive trading in mutual  funds, and SEC has proposed regulations that aim to eradicate late trading  and curb market timing. SEC’s proposed  regulations on late trading would amend the rule that governs how mutual  funds price and receive orders for share purchases and redemptions. To  try to curb market timing, a separate SEC proposal would require mutual  funds to impose a 2-percent redemption fee on the proceeds of shares  redeemed within 5 business days of purchase. SEC officials told us that more enforcement  actions are pending. In addition to its enforcement actions, SEC has issued guidance and new  regulations that address the negative impact of market timing on long-term  shareholders. DOL is not involved in the process of drafting the proposed  late-trading and market-timing regulations because it does not regulate  mutual funds. Plan participants could be distinctly  affected by the late trading proposal because it creates potential  complications for the processing of certain transactions unique to defined  contribution plans, such as loans. In addition, plan participants may pay  fees intended to deter short-term trading, including market timing, even on  certain transactions where there is clearly no intent to engage in abusive  trading. New Regulations Are Expected to Impose Costs on Service Providers and Investors

SEC’s proposed regulations on late trading and market timing are  expected to create additional costs for mutual funds and fund  intermediaries, including pension plan record keepers, which would likely  result in increased costs for all mutual fund investors, plan participants,  and plan sponsors. As a result of this demand, plan record keepers fear that  they would not be able to compete with mutual fund companies, who offer  their own funds and record-keeping services to pension plans and could  therefore allow plan participants to submit orders until 4:00 p.m. Officials  of one mutual fund company that also serves as a record keeper expressed  concerns that plan participants may demand alternative investment  products to mutual funds if they were to no longer be able to place orders  for fund transactions until the market closing time. To explain the regulatory actions taken by SEC and DOL to address late  trading and market timing, we interviewed SEC and DOL officials and  reviewed documents from both agencies. Appendix III: Comments from the Securities and Exchange Commission
Why GAO Did This Study

Mutual fund investments represent more than 20 percent of Americans' pension plan assets. Since late 2003, two abusive trading practices in mutual funds have come to light. Late trading allowed some investors to illegally place orders for funds after the close of trading. Market timing allowed some investors to take advantage of temporary disparities between the value of a fund and the value of its underlying assets despite stated policies against such trading. The Securities and Exchange Commission (SEC) has proposed regulations intended to stop late trading and reduce market timing. We were asked to (1) report on what is known about how these practices have affected the value of retirement savings of pension plan participants, (2) describe the actions taken by SEC and the Department of Labor (DOL) to address these practices, and (3) explain how plan participants may be affected by SEC's proposed regulations.

What GAO Found

The cost of late trading and market timing to long-term investors in mutual funds is unclear; however, it does not appear that these abuses affected pension plan participants more than other investors. While individual instances of abusive trading may not have had a noticeable effect on the value of funds held by long-term investors, the cumulative effect of such trading may be significant. Among 34 brokerage firms surveyed by the SEC, more than 25 percent reported instances of illegal late trading at their firms. However, numerous fund intermediaries that are not regulated by the SEC may also have permitted late trading. Trading abuses can be difficult to identify because, among other reasons, fund brokers aggregate the transactions of their clients and often do not share details of individual transactions with mutual fund companies. Ultimately, the effect of trading abuses on the savings of plan participants and other long-term fund shareholders is a function of which funds they invested in and for how long. SEC and DOL have taken steps to address abusive trading in mutual funds, and SEC has proposed regulations that aim to stop late trading and curb market timing. SEC and DOL are investigating these trading abuses, and SEC has already reached several settlements. DOL has issued guidance to pension plan sponsors and other plan fiduciaries on how they can fulfill their legal requirements to act "prudently" and in the best interests of plan participants who invest in mutual funds. To stop late trading, SEC has proposed that all fund transactions be received by mutual funds or designated processors before 4:00 p.m. eastern time in order for investors to receive the same day's price. To curb short-term trading, including market timing, SEC has proposed regulations that would impose a 2-percent fee on the proceeds of fund shares redeemed within 5 business days of purchase. DOL is not involved in the process of drafting these regulations because it does not regulate mutual funds, but it is considering how the proposals would affect pension plans. To the extent that SEC's proposed regulations stop late trading and market timing, they would benefit long-term mutual fund investors; however, the new rules could also affect such investors adversely, and pension plan participants more than others. The new regulations are expected to increase costs (e.g., for technology upgrades) that would be passed on to long-term mutual fund investors. In addition, plan participants could be distinctly affected by the late trading proposal because it creates potential complications in processing certain transactions unique to pension plans (e.g., loans). Further, the market timing proposal may result in plan participants paying fees intended to deter market timing, even when there is clearly no intent to engage in abusive trading. SEC officials told us that they are considering changes and alternatives to the proposed regulations that would address these concerns.