Distribution Channels Committee Newsletter Issue 2 – Third Quarter 2005

The Coming Transparency of Omnibus Accounts —
Technology Implications and a New Industry Study
by Leslie Bates, Product Marketing Manager, Access Data Corp

Recent regulations by the SEC have been aimed at preventing market timing abuses in Mutual Funds. SEC Rule 22c-2 is likely to have a meaningful impact on the relationship between fund companies and the distributors who sell their funds and the need for enhanced or new technologies to manage and analyze more information about mutual fund shareholders.

For years, mutual fund companies have not had access to all of the shareholder activity in their funds due to distributors who trade via omnibus accounts. Rule 22c-2 will change this by requiring that funds enter into a written agreement with each of its financial intermediaries under which each intermediary must provide the fund, upon request, information used to identify certain accounts and about their transactions in fund shares for the purposes of monitoring shareholder trading patterns.

Rule 22c-2 became effective in May 2005 and requires fund companies to be in compliance by October of 2006. Many fund companies are already pressuring distributors to provide them with omnibus account detail in order to meet the requirements of 38a-1. Rule 38a-1 (which had a compliance date of October 2004) requires that “a fund must have procedures reasonably designed to ensure compliance with its disclosed policies regarding market timing. These procedures should provide for monitoring of shareholder trades or flows of money in and out of the funds in order to detect market timing activity, and for consistent enforcement of the fund's policies regarding market timing.” In light of this rule, SEC examiners may review how fund companies monitor their distributors’ applications of market timing policies today.

The challenge for many mutual fund companies will be how to manage the data once it is received from Distributors. For example, in order to identify market timers that trade in omnibus accounts across multiple distribution platforms, fund companies must receive information that allows them to see the identity of individual shareholders in a consistent manner across distributors. The SEC included the requirement that the TIN be made available to the fund company for this reason. Fund companies will not only have the ability to monitor TINs within a distributor, but also to monitor them across distribution platforms as well. Therefore, fund companies may be able to pick up violations that individual distributors would miss.

So, what might be the impact to fund companies as it relates to the technology needed to provide the appropriate level of surveillance and data management? Does this mean that fund companies need to receive all of the data all of the time? Probably not, but it will likely mean that, when they see suspect activity at a particular distributor, they will need to “look up” the underlying account by it’s TIN and identify whether that same TIN is linked to accounts within other platforms trading the same fund. The ability to manage data and track communications at this level has meaningful technology implications.

To help us understand these new issues that our industry faces today, a new Compliance and Technology Survey sponsored by NICSA, Access Data and others and conducted by Diversified Management Resources will focus on technology and how it is used to support compliance requirements. Some of the questions in the survey focus on specific issues related to fund firms' detailed preparations such as how many data feeds from intermediaries they plan to establish, the timeframes for taking in the data, and data fields they will capture. In addition, the survey will ask participants about capturing tax identification numbers and the impact of that on the security of customer data. The survey will also query respondents on budgets, building versus buying systems solutions, email retention and practices, encryption when exchanging data and numerous other areas. The results of the survey are expected to be available in the Fall of 2005.

It is clear that the new compliance regulations will change the relationship between mutual fund companies and their distributors by creating a greater degree of collaboration to scrutinize trading activities at the individual account levels. The intent of the regulations is to provide full transparency into shareholder activity across all distribution platforms.

(Please note: Participation in the Compliance and Technology Survey is by Invitation Only. For more information, please contact Charlie O’Neill at coneill@dmrfinancial.com or 617-484-0074.)

For more information about the Distribution Channels Committee, contact the Committee co-chairs:

Martin Griffn, PFPC Inc.
martin.griffin@pfpc.com

Sue Ellyn Idelson, Fidelity Investments
Sue.Ellyn.Idelson@fmr.com

To contribute content for upcoming newsletters, contact Ellen Weinraub at NICSA at eweinraub@nicsa.org.