Home > Library > Stable Times > Volume 9, Issue 2  

401(k) Plans Wrestle with New Trading Restrictions

Trading restrictions in retirement savings plans aren't just for stable value funds anymore.

Nearly two years after the mutual fund industry was roiled by reports of market-timing and late trading by professional investors at the expense of individuals, many employers are taking steps to protect their employees from abusive trading in 401(k) plans. At the same time, mutual fund companies are instituting trading restrictions of their own. The result is a hodgepodge of new trading rules which, while beneficial for most investors in the long run, are making retirement plans more complicated for active investors and plan administrators.

Studies have shown that very few retirement plan investors engage in excessive trading. Still, those that do can hurt the long-term returns of their fellow investors by driving up transaction costs. “As fiduciaries, plan sponsors have a responsibility to take action if they think the trading behavior of some participants is hurtful to others,” observes Judy Schub, managing director of the Association for Financial Professionals’ Committee on Investment of Employee Benefit Assets, which represents more than 110 of the nation’s largest retirement plans. “The potential is there to hurt all the participants because all participants bear the cost of trading.”

“This is a really important issue to plan sponsors,” adds Kim McCarrel, relationship manager with stable value manager INVESCO Institutional. “I get a lot of questions from them about what other sponsors are doing.”

Stable value funds, of course, have traditionally imposed restrictions on trading between their funds and directly competing investments, such as money market funds. The aim of such rules is to prevent plan participants from trying to arbitrage the difference in yields on the two products during periods of sharply rising interest rates. Cash moving out of stable value into money market funds at such times might affect returns in stable value funds, adversely impacting long-term shareholders.

Now such restrictions are becoming common for all types of retirement-plan investments. In a survey of plans of varying sizes late last year, Deloitte Consulting LLP found that 23 percent had implemented broader policies restricting the frequency of inter-fund transfers among investment options, while 27 percent had imposed short-term trading fees for one or more investment options. Half the survey respondents said that if they found participants engaging in excessive trading they would send them a note advising them to stop. The rest said they would either freeze the participant’s account or take other action.

Among very large plan sponsors—those with assets in excess of $1 billion—the adoption of trading restrictions has been even more widespread. When CIEBA surveyed its members last year, 69 percent of the respondents said they had already implemented such restrictions, and another 14 percent said they were planning to do so. The most popular option was limiting the number of trades plan participants could make (cited by 31 percent of respondents), followed by implementation of mandatory holding periods (25 percent) and redemption fees (23 percent). The most common redemption fee was two percent, and the most common holding period to avoid a redemption fee was 30 days.

As noted, many mutual fund companies also have begun to limit trading by retirement plan participants in their funds. Fidelity Investments, for example, implemented an excessive trading policy last December limiting retirement plan participants to one round-trip transaction per fund within any rolling 90-day period, subject to an overall limit of four roundtrip transactions across all funds over a rolling 12-month period. It defines a round trip as an exchange into and then out of a fund within 30 days. T. Rowe Price has a similar policy. Both firms this year also began imposing redemption fees on certain of their funds held in retirement plans. Fidelity generally imposes the fees regardless of the reason for the redemption, though, while T. Rowe Price generally does so only when investors transfer assets from one fund to another. The T. Rowe Price fees would not apply, for example, to a redemption made because the participant was leaving the plan due to retirement or a job change.

A new rule issued by the Securities & Exchange Commission earlier this year limits redemption fees imposed by fund companies to two percent of the value of the transaction. Actual fees vary from one fund company to the next, and, at times, among funds offered by the same company. This has made more work for the third-party record keepers hired by most employers to manage their plans, especially when a plan offers mutual funds from a variety of fund families.

Transaction activity redemption fees in mutual funds typically stay in the mutual fund where the transactions happened as on offset to the theoretical extra fund costs to manage the transactions. If a plan imposed transaction fees associated with transactions in a stable value fund, presumable those transaction fees would also stay in the stable value fund as an additional income source for the remaining participants in the stable value fund.

To bring some semblance of order to the marketplace, the National Defined Contribution Council/SPARK Institute, a group of major retirement plan providers, has proposed to the SEC that the industry standardize the types of transactions to which redemption fees apply. “I think the industry is gravitating toward this,” says NDCC/SPARK Institute President Charles Veith, also president of fund provider T. Rowe Price Retirement Plan Services. “We have already seen some fund complexes change their policies.” The NDCC/SPARK Institute has recommended to the SEC that redemption fees apply only to participant-initiated exchanges of shares that were acquired in connection with a prior participant-initiated exchange. That means the charges wouldn’t apply, for example, to a sale of shares acquired through routine payroll deductions.

Some plan sponsors looking for consistency in their trading policies are taking matters into their own hands. Veith says those sponsors have looked at the restrictions imposed by the various funds they offer, picked the policies that seem most appropriate to them, and told the funds that either they must use that standard or see their funds removed from the plan.

Mary Kazan, group vice president for corporate benefits at apparel maker Phillips-Van Heusen Corp. in Bridgewater, New Jersey, is among the plan sponsors wrestling with the new restrictions. “We have five or six different fund companies represented in our plan, and until recently, they had all exempted retirement plan participants from their trading restrictions,” Kazan says. “Now, some of the funds have said those restrictions apply to retirement plans, so we have had to start communicating to employees about them.”

Kazan says her company is looking closely at the funds that have implemented new restrictions to decide whether they’re still worth offering. “Some have gone kind of overboard,” she says. Already, Phillips-Van Heusen is seriously considering eliminating one small cap fund that recently imposed a 1 percent redemption fee on roundtrip transactions that occur within a 180-day period. That isn’t the only reason the company is considering removed from the fund—the plan offers another small-cap fund that has been performing more strongly—but Kazan says the new fee helped to solidify the company’s interest in dropping it.

Another plan sponsor, who asked not to be identified, noted that his plan has had restrictions on excessive trading in its company stock fund and its international stock fund for several years, but is now planning to add restrictions on trading in its core, single-asset-class funds, too. “We’re shifting from having a reactive approach to this issue to a more anticipatory approach,” he says. “We’re basically saying that frequent trading is bad and that we should have some sort of anticipatory rule in place such that it just can’t occur—rather than waiting for it to occur and then dealing with it.”

Given the interest of plan providers in keeping their plan sponsor clients happy—and minimizing their own costs—it’s likely that the retirement plan market ultimately will introduce some level of standardization to its policies on trading restrictions and redemption fees. Until then, plan participants can take solace in the knowing their long-term interests are being protected in ways they weren’t just a year or two ago.

Read Next: For Want of the Nail, the Shoe was Lost….403(b) Plans Find the Nail