On February 14, 2023, Americans for Tax Reform submitted a comment letter in response to the Securities and Exchange Commission’s (SEC) proposed rule, entitled, Open-End Fund Liquidity Risk Management Programs and Swing Pricing; Form N-PORT.
The letter explains that the rule discriminates against mutual funds by requiring (1) swing pricing on net purchases and net redemptions of shares in a mutual fund, (2) a hard close pricing time, (3) and liquidity requirements that will limit the availability of certain types of mutual funds. The increased costs required to comply with the rule’s provisions will likely be passed down to individual investors and retirees in the form of lower returns.
ATR believes that the amendments made in this rule will be especially harmful to retirees because of the colossal exposure retirement assets have to mutual funds:
63% of 401(k) plan assets are held in mutual funds. Mutual funds are also ‘the most commonly used investment vehicles in 529 savings plans.’ Additionally, there are approximately $12.6 trillion of defined contribution plan and individual retirement account assets invested in mutual funds.
The letter notes that swing pricing is already available to over 7,000 mutual funds, and yet none of them use it. The SEC has previously admitted that mandatory swing pricing could have a negative impact on funds and individual investors:
In a notice of proposed rulemaking for open-end funds, the SEC stated that “the potential disadvantages of swing pricing…include increased performance volatility and the fact that the precise impact of swing pricing on particular purchase and redemption requests would not be known in advance and thus may not be fully transparent to investors. In addition, the swing factor used by a fund on a particular day may not capture all costs incurred by the fund resulting from purchases or redemptions that day.”
Next, the letter explains the effect of the rule’s “hard close” pricing time on U.S. households:
The increased costs from altering the order flow information to comply with the hard close will significantly affect retirees. In 2021, 81% of U.S. households purchased mutual fund shares through employer-sponsored retirement plans (e.g., defined contribution plans and employer- sponsored individual retirement accounts). Only 18% of U.S. households purchased shares of mutual directly from the funds.
Finally, the letter discusses why the new liquidity classifications must not be implemented. They intend to discriminate against less liquid underlying assets without any evidence that the amendments will significantly benefit investors or ward off future liquidity crunches:
The Rule’s uniform restrictions on liquidity requirements for open-end funds will likely increase costs on fund investors and limit the option for higher return investments. While bank loan funds may be less liquid, they offer higher returns for investors who want a more diversified and more aggressive investing strategy. They also offer a hedge against changes in interest rates because the underlying loans pay interest based on a floating rate. The reclassification of liquid assets will likely eliminate the use of bank loan funds because instead of counting as ‘less liquid’ they will now be considered ‘illiquid.’ If bank loan funds disappear, this could deter banks from offering the same amount of below investment-grade floating rate loans and siphon liquidity away from business entities that may rely on certain banks to take greater risks in offering capital. Selling the illiquid securities could exacerbate market illiquidity during times of stress.
There is no quantifiable reason for the change, and no authorization from Congress has directed the SEC to pursue this shift in reclassifying assets. Systematic disqualification of certain funds is the antithesis of facilitating capital formation.
The letter explains that the rule as drafted will increase costs on mutual funds, which will pass on the costs to retirees. The rule fails to provide substantive economic analysis justifying the rule, which will most likely render it arbitrary and capricious under the Administrative Procedure Act.
Read the full letter here.