[Federal Register: March 10, 2008 (Volume 73, Number 47)]
[Proposed Rules]
[Page 12665-12669]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr10mr08-13]
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Proposed Rules
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.
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[[Page 12665]]
FEDERAL RETIREMENT THRIFT INVESTMENT BOARD
5 CFR Part 1601
Participants' Choices of TSP Funds
AGENCY: Federal Retirement Thrift Investment Board.
ACTION: Proposed rule with request for comments.
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SUMMARY: The Federal Retirement Thrift Investment Board (Agency)
proposes to amend its interfund transfer regulations to limit the
number of interfund transfer requests to two per month. After a
participant has made two interfund transfers in a calendar month, the
participant may make additional interfund transfers only into the
Government Securities Investment (G) Fund until the first day of the
next calendar month.
DATES: Comments must be received on or before April 9, 2008. Comments
submitted in response to the interim regulation need not be
resubmitted; they will be considered as part of this rulemaking
process.
ADDRESSES: Comments may be sent to Thomas K. Emswiler, General Counsel,
Federal Retirement Thrift Investment Board, 1250 H Street, NW.,
Washington, DC 20005. The Agency's Fax number is (202) 942-1676.
FOR FURTHER INFORMATION CONTACT: Megan Graziano on (202) 942-1644.
SUPPLEMENTARY INFORMATION: The Thrift Savings Plan (TSP) was
established by the Federal Employees' Retirement System Act of 1986
(FERSA). FERSA created a new retirement program for Federal employees
which consists of a reduced defined benefit plan component supplemented
by a defined contribution retirement savings and investment program
commonly known as the TSP.
Statutory Basis and History of TSP Interfund Transfers
After three years of study, the Congress determined that the TSP
would be a passive, long-term investment vehicle. This approach is
consistently reflected throughout the legislative history of the
enabling legislation. The statute requires two opportunities each year
for participants to transfer their investments among the TSP investment
funds. 5 U.S.C. 8438(d). Additional opportunities may be provided under
regulations issued by the Executive Director.
This ``interfund transfer'' (IFT) program was first implemented in
1988 under regulations which coupled two annual IFT opportunities with
the then-statutory twice-a-year contribution open seasons. The March
1989 booklet entitled Summary of the Thrift Savings Plan for Federal
Employees introduced participants to the concept of interfund transfers
as follows:
You can transfer funds only twice a year, once in connection
with each open season. Please consider this before you decide on the
allocation of your contributions among the Funds. Your Plan
contributions are invested for your retirement, and you should make
your investment decision with this long-term goal in mind.
This long-term investment strategy (as opposed to a short-term
strategy of market-timing) remains an essential element of the TSP. The
April 2007 TSP Fund Information sheets recommend a ``buy and hold''
strategy with periodic--as opposed to frequent--rebalancing.
The enactment of legislation removing restrictions on TSP
investments led to the first Agency review of the TSP interfund
transfer policy. Until 1990, employees covered by the Federal
Employees' Retirement System (FERS) were allowed to invest only a
percentage of their own contributions outside the Government Securities
Investment (G) Fund. All employer contributions and all contributions
by employees covered by the Civil Service Retirement System could, by
law, be invested only in the G Fund.
The Agency asked Congress to ease these restrictions in order to
simplify program administration. Congress ended the restrictions as
part of the Thrift Savings Plan Technical Amendments of 1990. Going
forward, all participants were to be allowed to invest or reinvest in
any TSP fund. In preparing for implementation, the Agency reexamined
the policy of two-a-year interfund transfers during open seasons due to
the anticipated growth in the volume of IFTs.
In conducting this review, the Executive Director identified four
considerations:
--The practices of other plans;
--administrative/operational concerns;
--costs; and
--service to participants.
The Executive Director recommended that the Agency's Board members
approve de-linking IFTs from open seasons and allow up to four
transfers a year. These transfers were linked to the TSP's then monthly
valuation cycle, thus allowing a transfer in any month up to four times
a year. This policy was based on the following findings: Other plans
were liberalizing allowable IFTs; IFT request processing would be
spread over more months, eliminating operational bottlenecks; trading
costs would be reduced by processing smaller trades on twelve days
rather than larger trades on two days each year; and, participants who
missed an IFT deadline would no longer have to wait six months for
another opportunity.
In making his recommendation, the Executive Director cautioned that
allowing more frequent transfers simply ``to satisfy the demand of a
relatively small group of participants, could result in increases in
administrative costs to all participants which would be difficult to
justify. I would also be concerned that such a policy would be viewed
as encouraging participants to focus on market conditions each month in
making their asset allocations. Such a short term focus would not be
consistent with the Board's policy of encouraging long term financial
planning for retirement.''
Thus, the initial two-a-year IFT regulatory requirement was
liberalized, by regulation, but only after careful study and a clear
restatement of the fundamental long-term investment policy.
In 1995, the policy was again reconsidered. The goal was to ensure
that any participant withdrawing an account balance be permitted to
transfer to the G Fund while withdrawal processing was completed.
The 1995 policy review examined the same elements as the 1990
review. The Agency research found that, rather than allow one special
withdrawal-based transfer, the trend among defined contribution plans
was to allow at least
[[Page 12666]]
12 IFTs each year (this also happened to be the greatest number
possible under the monthly-valued system then in place at the TSP). By
that time, administrative/operational concerns were minimized for the
TSP because IFT requests had largely migrated from paper processing to
telephone keypad entry. After a thorough review, the Agency expanded
IFT opportunities to one-a-month, twelve-a-year in April 1995.
In October 1995, the Agency began designing a new TSP record
keeping system. The initial plan anticipated that the new system should
accommodate unlimited IFTs and have the capability to levy a charge if
it was later determined that charges were necessary or desirable.
However, by 1997, it was clear that frequent trading was still not a
problem in the TSP. Further action on a design that would assess a
charge for frequent trading was discontinued.
A staff review regarding IFTs in 1998 found that the policy adopted
in 1995 continued to achieve the intended policy goals. The review
found that 91 percent of participants who made IFTs requested one (75
percent) or two (16 percent) during the year. Just 42 participants
requested the maximum of 12.
From an administrative/operational perspective, IFT requests were
processed without bottlenecks via the ThriftLine (telephone keypad) and
were being migrated to an even more efficient processing environment on
the new TSP Web site.
From an investment perspective, transfers were netted each month,
thus offsetting uncorrelated ``buys'' with ``sells'' before the monthly
IFT amounts were forwarded to the asset manager for investment.
Further, under Agency contracts, the asset manager executed ``cross
trades'' with other institutional investors in its commingled funds,
reducing trading costs and minimizing deviations from the indexes
tracked by the TSP.
Participants were satisfied with the level of service, which was
comparable to what was being offered in private sector plans. Further,
allowing 12 unrestricted interfund transfers a year--the maximum
possible number under a monthly-valued system--had had no adverse
effect on administrative operations or trading costs. Therefore, no
restrictions were initially required when the TSP moved from its
monthly-valued record keeping system to a daily-valued platform in
2003. This had the effect of increasing interfund transfer
opportunities from one per month, executed at month end, to one per
business day.
The Agency monitored interfund transfer activity by observing the
overall number of transfers and periodically determining whether
``frequent trading'' was becoming a problem. For example, in 2004, the
Executive Director requested a check of 2003 data which disclosed 150
participants were requesting frequent IFTs for the apparent purpose of
short-term market timing. There was no apparent adverse consequence of
this activity on other participants in the TSP.
The Problem
This situation began to change in 2006. As the number of interfund
transfers increased and as a small number of participants with
relatively large account balances engaged in frequent interfund
transfers, a pattern started to emerge. These participants began to
focus on the International Index Investment (I) Fund, which tracks the
Morgan Stanley Europe, Australasia, and Far East Index. The attraction
may have been based on the notion that by the noon Eastern Time
deadline for submitting an IFT request, a participant might anticipate
whether overseas markets would open up or down. Since an IFT request is
processed based on the closing price for the previous day, this was
seen as an opportunity for arbitrage. Although ``fair valuation'' was
introduced to eliminate the arbitrage potential, some participants,
nevertheless, continued this behavior. Moreover, over the past year,
this behavior has become more frequent and less random.
This activity disrupts the Agency's carefully designed cost-
minimization efforts in three distinct ways: Increased transaction
costs (including commissions paid to brokers, transfer taxes, and
market impact); increased futures/cash position; and forgone interest.
Market impact, which is impossible to calculate in advance, is a
major problem generated by the correlated actions of those individuals
attempting to actively manage their TSP investments based on
anticipated short-term market movements.
By statutory design, the TSP funds are passive, long-term
``pooled'' investments required to replicate the performance of
selected broad index funds. The intent of IFTs is to allow periodic
rebalancing. There are many benefits inherent in this arrangement
established by the original statute. However, the vast majority of
participants who follow this long-term strategy are subjected to
greater risk when a determined cohort of participants frequently moves
funds in anticipation of market movements.
Simply stated, when this small cohort rapidly removes funds in
anticipation of short-term market losses, any losses which in fact
materialize are spread over fewer remaining participants and are
therefore more severe for those who maintain the long-term approach.
Those who rapidly shift out secure the higher value based on the
closing price for the day, while the remaining investors bear the
losses when the shares are sold at the lower opening price on the
following business day.
An extreme example would involve a large, highly-correlated Friday
afternoon transfer by market timers wishing to eliminate their exposure
in the I Fund based on anticipated market losses due to world events.
If those events come to pass, in particular during a three-day U.S.
weekend, world markets could fall dramatically, and the smaller number
of remaining investors would bear the totality of the losses.
Defenders of this practice argue that the market timers might guess
wrong, and, in such a case, positive earnings would be spread over a
smaller investor base. They also argue that they are only controlling
their own funds.
This rationale, however, ignores the fact that, by their actions,
these market timers are exposing passive, long-term investors to a risk
they never agreed to accept. These bystanders are simply using the TSP
in the passive, long-term method for which it was designed.
Additionally, the market timers are forcing the fund manager to
take extraordinary measures to mitigate the adverse impact of an
investment behavior for which the TSP was not designed. These
extraordinary measures generate costs borne by all participants and
adversely affect the plan manager's ability to precisely replicate the
performance of the selected indexes.
Frequent rapid fire transfers in the TSP reached a zenith in
October, 2007. One example:
--On October 19, $371 million was transferred into the I Fund.
--On October 24, three business days later, $391 million was
transferred out of the I Fund.
--;$295 million of those transactions was attributable to 2,018
participants who purchased on 10/19 and redeemed on 10/24.
--323 of these participants transferred $250,000 or more for a total of
$110 million on each day.
--In the previous 60 days, these 323 participants had completed 5,804
exchanges of the I Fund for a total dollar amount of $1.9 billion. Two
[[Page 12667]]
hundred and seventy-eight of those participants with large accounts
went on to repurchase the I Fund two days later on October 26.
--1,656 participants bought the I Fund on October 19, sold it on
October 24 and repurchased it on October 26.
Limits Established by Other Funds/Plans
The Agency is not alone in recognizing the problems caused by
frequent traders. Indeed, there are supplemental plans offered by some
U.S. Government agencies, which have taken measures to reduce interfund
transfer activity. The FDIC Savings Plan charges a 2 percent redemption
fee on shares of the international stock fund which are not held for at
least 90 days. The Thrift Plan for the Employees of the Federal Reserve
System does not allow participants to redeem shares of any fund for 14
days after purchase.
Beginning with the ``late trading'' scandal of 2003, the mutual
fund industry began to place limits on trading. Trading limits imposed
by major mutual fund groups include:
------------------------------------------------------------------------
Mutual fund group Trade limit Time frame
------------------------------------------------------------------------
AIM Funds................... 4 exchanges......... 1 calendar year.
Ariel Capital Management.... 4 round trip 1 year.
exchanges.
Federated................... 2 trades............ 30 days.
Harbor...................... 3 round trips (in/ 12 months.
out within 30 days).
Hotchkiss and Wiley......... 1 round trip........ 12 month period.
ING......................... 4 trades............ 360 days.
Janus....................... 4 round trips....... 12 months (may
reject even before
this limit is
reached.)
Neuberger and Berman........ 1 trade............. 60 days.
Northern.................... 2 trades............ 90 days.
PBHG........................ 4 trades............ 360 days.
Royce....................... 1 trade............. 30 days.
Van Eck..................... 6 trades............ 360 days.
Vanguard.................... After sale cannot 60 days.
repurchase.
------------------------------------------------------------------------
Defined contribution plans which offer mutual funds as their
investment choices can pass on the funds' restrictions or impose more
stringent restrictions of their own. The Hewitt survey entitled Trends
and Experience in the 401(k) Plans 2007 found that 73 percent of
surveyed plans have placed restrictions on some or all of their funds.
While the Securities and Exchange Commission (SEC) has no direct
oversight authority with respect to the TSP, its views on frequent
trading and specifically its directive to mutual fund board members is
instructive.
The SEC's rule 22c-2(a)(1) under the Investment Company Act of
1940, which authorizes mutual funds to impose redemption fees when it
is determined that such fees are in a fund's best interest, took effect
in October 2006. In the release adopting this rule (Inv. Co. Ac Rel.
No. IC-26782, March 11, 2005), the SEC noted, ``Excessive trading in
mutual funds occurs at the expense of long-term investors, diluting the
value of their shares. It may disrupt the management of a fund's
portfolio and raise the fund's transaction costs because the fund
manager must either hold extra cash or sell investments at inopportune
times to meet redemptions.''
According to the SEC: ``Under the rule [22c-2], the board of
directors must either (i) approve a fee of up to 2% of the value of
shares redeemed, or (ii) determine that the imposition of a fee is not
necessary or appropriate. Id. A board, on behalf of the fund, may
determine that the imposition of a redemption fee is unnecessary or
inappropriate because, for example, the fund is not vulnerable to
frequent trading or the nature of the fund makes it unlikely that the
fund would be harmed by frequent trading. Indeed, a redemption fee is
not the only method available to a fund to address frequent trading in
its shares. As we have stated in previous releases, funds have adopted
different methods to address frequent trading, including (i)
restricting exchange privileges; (ii) limiting the number of trades
within a specified period; (iii) delaying the payment of proceeds from
redemptions for up to seven days (the maximum delay permitted under
section 22(e) of the Act); (iv) satisfying redemption requests in-kind;
and (v) identifying market timers and restricting their trading or
barring them from the fund.''
In its review of the best practices of the mutual fund industry's
efforts to curb frequent trading, the Agency learned that the exact
mechanisms funds employ to deter frequent trading are many and varied
depending on unique circumstances, but they share two common themes:
Fees or transaction limitations.
Many fund families charge redemption fees for shares which are
redeemed within 30, 60, or 90 days of purchase. T. Rowe Price, for
example, levies fees on 27 funds, including a 2 percent redemption fee
on shares of its International Index Fund and a 0.5 percent fee on
shares of its Equity Index 500 and Extended Equity Market Index Funds,
if they are sold within 90 days of purchase. TIAA-CREF (with $400
billion of assets under management and 3 million participants) charges
a redemption fee of 2 percent on shares of its International Equity,
International Equity Index, High Yield II, Small-Cap Equity, Small-Cap
Growth Index, Small-Cap Value Index or Small-Cap Blend Index Funds
redeemed within 60 days of purchase. We noted particularly that the fee
is a percentage of the dollar amount transacted, not a flat processing
charge.
When brokerage firms charge $10 to execute a stock trade, they know
exactly how much it costs them to make that transaction. Mutual fund
managers (and the TSP) cannot determine the exact amount of costs to
the plan from interfund transfer activity for the following reasons.
First, each day, a price for each fund is determined based on closing
stock prices for that day. However, the fund manager does not execute
every stock trade at that closing price. Any difference is market
impact and is charged or credited to the fund, thus impacting the
returns of the long-term holders. Second, to accommodate the large
trades which result from frequent IFT activity, managers must keep a
larger liquidity pool, which causes performance to deviate from that of
the index. Lastly, for the TSP, when the liquidity pool is depleted as
a result of a number of large trades in a row, cash due to the TSP is
not received for
[[Page 12668]]
up to three days, costing participants forgone interest. None of those
three costs is calculable in advance, and all three are different every
single day. Because it is impossible to determine how much to charge
for each transaction, mutual fund families assess a percentage of the
dollar amount transacted.
Many fund families employ trading restrictions similar to
Vanguard's whereby an investor may not repurchase any fund within 60
days after a redemption.
We would also note that both TIAA-CREF and Vanguard, among others,
use a double-barreled approach by charging a fee on top of the trading
restrictions for some funds. For example, if an investor sells the
Vanguard Developed Markets Index Fund (similar to the TSP's I Fund)
within 60 days of purchasing it, that investor is charged a 2% fee AND
cannot repurchase the fund for 60 days.
Proposed TSP Solution
The hallmark of the TSP is simplicity. Although the problem
described above may not be amenable to a single solution (as evidenced
by the multi-layered restrictions including monthly limits/no-buyback
rules/redemption fees imposed by various private sector funds and
plans), the Agency is currently proposing a straightforward rule that
will allow two unrestricted transfers each month, followed by unlimited
opportunities to transfer amounts to the Government Securities
Investment (G) Fund. Our analysis on the effect of such a limitation
shows that it would have reduced the historic levels of November 2007
trade dollar volumes by 53%.
In developing its recommendation, the Agency chose not to pursue
redemption fees because it is impossible to correctly assign the exact
costs to those who are making interfund transfers. Additionally,
imposing a percentage fee would deny our participants the ability to go
to the safe harbor of the G Fund at any time for no charge. The Agency
considers that capability to be of paramount importance. A fee-based
system would especially punish an infrequent trader who may wish to
redeem within 30, 60, or 90 days (depending on the policy) because the
market is declining. In this situation, the participant could face
losing two percent of his/her investment in addition to the market
decline, a worst case scenario.
Further, our approach is more liberal than most, if not all, of the
restrictions reviewed. It allows participants to rebalance up to twice
a month. Indeed, our two investment consultants, Mercer and Ennis
Knupp, have conducted studies showing that rebalancing an account more
than monthly or quarterly is ineffective. We therefore consider our
approach to be more accommodating than necessary for optimal
rebalancing frequency and demonstrably more liberal than the policies
of 40 record keepers which use the same processing system as the TSP.
The advantages of our current approach include ease of
understanding by the 3.9 million TSP participants as well as
administrative simplicity. In fact, the Agency's proposal will affect a
very small number of TSP participants. Our review of 2007 data shows
that more than 99% of participants requested 12 or fewer interfund
transfers. The Agency expects that, when coupled with our educational
and outreach efforts, this structural limit of two per month will
virtually eliminate the problems associated with frequent interfund
transfer activity.
The Executive Director has sent a letter to every one of the 3.9
million participants explaining the situation and reminding all
participants that the TSP was designed by Congress to be a passive,
long-term vehicle designed to replicate the selected indexes.
Participants whose frequent transfer requests reflect an effort to
time the markets (i.e., those who request interfund transfers in
reaction to, or anticipation of, short-term market conditions) might
still affect the returns of others in the pooled investments, as well
as the Plan's ability to replicate the indexes, through less frequent
yet more determined activity. This has the potential to become a
significant problem as account balances grow over time. If participants
with large account balances request large interfund transfers in a non-
random manner, the Agency may reconsider imposing the more restrictive
limitations employed by other plans and mutual funds. If additional
restrictions prove necessary, the Agency will announce additional
rulemaking at a future date.
Regulatory Flexibility Act
I certify that this regulation will not have a significant economic
impact on a substantial number of small entities. It will affect only
Thrift Savings Plan participants and beneficiaries. To the extent that
limiting interfund transfers is necessary to curb excessive trading,
very few, if any, ``small entities,'' as defined in 5 U.S.C. 601(6),
will be affected by the final rule. This is because the Thrift Savings
Plan is sponsored by the U.S. Government and because the interfund
transfer limitations are likely to affect primarily federal employees,
members of the uniformed services, and an insubstantial number of
financial advisors who may provide advice in connection with the Fund.
Paperwork Reduction Act
I certify that these regulations do not require additional
reporting under the criteria of the Paperwork Reduction Act.
Unfunded Mandates Reform Act of 1995
Pursuant to the Unfunded Mandates Reform Act of 1995, 2 U.S.C. 602,
632, 653, 1501-1571, the effects of this regulation on state, local,
and tribal governments and the private sector have been assessed. This
regulation will not compel the expenditure in any one year of $100
million or more by state, local, and tribal governments, in the
aggregate, or by the private sector. Therefore, a statement under
section 1532 is not required.
Submission to Congress and the Government Accountability Office
Pursuant to 5 U.S.C. 810(a)(1)(A), the Agency submitted a report
containing this rule and other required information to the U.S. Senate,
the U.S. House of Representatives, and the Comptroller General of the
United States before publication of this rule in the Federal Register.
This rule is not a major rule as defined at 5 U.S.C. 814(2).
List of Subjects in 5 CFR Part 1601
Government employees, Pensions, Retirement.
Gregory T. Long,
Executive Director, Federal Retirement Thrift Investment Board.
For the reasons set forth in the preamble, the Agency proposes to
amend 5 CFR chapter VI as follows:
PART 1601--PARTICIPANTS' CHOICES OF TSP FUNDS
1. The authority citation for part 1601 continues to read as
follows:
Authority: 5 U.S.C. 8351, 8438, 8474 (b)(5) and (c)(1).
2. Amend Sec. 1601.32, by revising paragraph (b) to read as
follows:
Sec. 1601.32 Timing and Posting Dates.
* * * * *
(b) Limit. There is no limit on the number of contribution
allocation requests. A participant may make two unrestricted interfund
transfers (account rebalancings) per account (e.g., civilian or
uniformed services), per calendar month. An interfund transfer will
count
[[Page 12669]]
toward the monthly total on the date posted by the TSP and not on the
date requested by a participant. After a participant has made two
interfund transfers in a calendar month, the participant may make
additional interfund transfers only into the G Fund until the first day
of the next calendar month.
[FR Doc. E8-4776 Filed 3-7-08; 8:45 am]
BILLING CODE 6760-01-P