Unprecedented board uprising spurred by fears about swing pricing’s impact on shareholders

Behind-the-scenes conversations convinced trustees, traditionally quiet on regulation, to speak out en masse against perceived SEC overreach

The flood of negative response to the SEC‘s swing pricing proposal last month included one unique source of opposition: More than 30 fund boards stepped up during an industry-wide mobilization to combat a rule many view as a once-in-a-lifetime threat to mutual fund shareholders.

They relied on logistical support from counsel and industry groups like the Independent Directors Council (IDC) and the Mutual Fund Directors Forum (MFDF), but the anger fueling the movement came from a normally non-demonstrative population of trustees increasingly fed up with the breakneck pace of SEC rulemaking under chair Gary Gensler and what they view as an effort to remake the fund market in ways detrimental to the interests of shareholders.

“It was unprecedented,” said Maureen Miller, a fund lawyer at Vedder Price PC, of the board response to the swing pricing proposal the SEC announced in November. “It really had to do with the nature of the SEC’s proposal, which I think was also unprecedented.”

As of press time, 32 boards had submitted comment letters — including several that claimed to be doing so for the first time ever — with more possibly to come, as it appeared the SEC was allowing submissions to trickle in after the Feb. 14 deadline.

The current count already surpasses the previous record, set by the 2004 independent chair proposal, which received 19 letters from boards (plus 13 letters from independent trustees writing as individuals) at a time when the MFDF was two years old and the IDC did not yet exist.

Trustees are hoping the historic turnout will highlight both the proposal’s potential to harm shareholders and the industry’s frustration with the proposal, which they said would create enormous changes by applying a “one size fits all” solution to a problem that may not exist.

“Thirty or more boards are shaking their heads about the sweeping nature of these rule changes, the negative impacts they would have on many funds, and … the sense that this just feels like regulation for the sake of regulation,” said Neuberger Berman Funds chair Tom Seip.

“My overarching feeling was, enough is enough.”

Why this rule was different

It’s not unusual to see one or two boards comment on an SEC rule proposal, but most tend to avoid public debate and rely on industry associations like the IDC and MFDF to speak out on their behalf.

Trustees may complain about aspects of regulations like the liquidity  or derivatives rules, but they also acknowledge that most rule proposals serve a purpose, according to Kathleen Barr, chair of the William Blair Funds and US Bank’s Professionally Managed Portfolios, both of which commented on the proposal.

“Independent directors have a long history of supporting sensible regulation,” said Barr, who is also chair emeritus of the IDC governing council. “We evaluate each proposal on its own merit.”

There is also a financial cost to submitting a comment, because having lawyers analyze a 400-page rule proposal and then draft or revise a written response can use up precious billable hours and, therefore, shareholder assets.

Faced with such considerations, boards usually conclude it is not worth it to comment on regulation.

The swing pricing rule stands out from any other proposal in living memory, however, by threatening to upend the shareholder experience to such a degree that it lit a fire under trustees, whose primary responsibility is to defend shareholder interests.

“We’re not a trade association commenting on every proposal, but when we feel that our shareholders are particularly affected by a rule, we feel that we can add to the conversation by commenting,” said Theresa Hamacher, chair of the Morningstar Funds.

In their comments, many boards called for the SEC to withdraw the sweeping proposal, which aims to address what regulators see as underlying structural liquidity issues that surfaced in March 2020, when some fund investors withdrew money due to fears about the economic impact of the Covid-19 pandemic.

“Generally speaking, my sense is that the degree of board reaction was commensurate with the degree to which the proposal would upend the status quo,” said Nathaniel Segal, a fund lawyer at Vedder Price.

The proposal would require all mutual funds to add a series of liquidity risk-management processes and implement swing pricing, a mechanism designed to discourage shareholder dilution from fund runs. When redemptions spike, a fund can “swing” its net asset value (NAV) higher to offset transaction costs incurred by the need to sell assets quickly, thus ensuring that shareholders bearing the cost are those redeeming their investments rather than those who remain invested in the fund.

Swing pricing is widespread in Europe but has never been implemented by a U.S. fund, partly because it requires fund managers to be aware of the entire day’s orders before calculating their NAV. U.S. funds typically calculate their daily NAV at a “soft” closing time of 4pm ET but allow orders placed with intermediaries before 4pm to transact at that price until the following morning.

Therefore, to make swing pricing possible, the SEC’s proposal would mandate a “hard close,” requiring funds to have received a customer order by 4pm ET for the customer to qualify for that day’s NAV.

It would also update parts of the liquidity risk management programs the SEC required funds to adopt in 2019, including by eliminating the “less liquid” classification.

While no part of the proposal was popular, commenters directed the most criticism at the hard close, which they said would force investors who hold shares via intermediaries to place orders earlier than investors who can buy shares directly from the fund in an eastern time zone, rendering 401(k) investors and many others “second-class citizens.”

“It’s unfair to that retirement investor. And think about if you live in Hawaii. Are you going to get up at 5 o’clock in the morning?” Barr said. “It makes it very complicated and very confusing for that retail investor, and that’s who we’re talking about here.”

Commenters also argued that the SEC’s rationale for proposing the rule was facile and not supported by any actual evidence of dilution from March 2020; many endorsed a particularly pointed letter from the Investment Company Institute (ICI) in which the ICI cited its own data suggested that dilution fears had played little to no role in the panic among high-yield bond fund shareholders that month.

“I think it’s also odd that they made such wide-ranging proposals with large impacts on the industry without having done an analysis of shareholder benefits versus cost,” Seip said. “There’s nothing broken here, so why engage in these wide-ranging rules when the system is working just fine?”

Behind-the-scenes collaboration

Protests about the swing-pricing proposal flooded in from every corner of the industry almost immediately after the SEC released it in November, but the proposal’s scope and complexity made response difficult without extensive analysis. For trustees, this meant huddling with fund management and lawyers to assess the potential impact the rule could have on their shareholders.

At Neuberger Berman, for instance, trustees met the month after the release to examine the rule’s implications, which they immediately found worrisome.

“At our December board meeting, we had a fairly thorough-going conversation about these proposed rules,” Seip said. “We talked about it with our counsel [and] we talked about it with the internal counsel at Neuberger, who took us through the impacts on some of the funds that certainly weren’t positive and didn’t seem to make any sense in terms of investor protections.”

As boards around the country began reaching similar conclusions, trustees turned to outside educational resources, such as webinars and meetings hosted by the IDC and the MFDF.

Both the IDC and MFDF denied actively recruiting boards to write comment letters at these events, but they also made no secret of their predictions that the proposal would have negative effects for fund shareholders.

“We made a very concerted effort to ensure that boards were aware of the nature of this particular proposal and what some of the impacts would be,” said IDC managing director Thomas Kim. “I would say that we were supportive of boards who considered submitting a comment letter because of the significance of the proposal and the extent to which the proposal would impact the funds that a given board would oversee.”

Industry events also served as forums for participants to share their fears about the new regulation and talk with each other about taking the potentially scary step of sending their criticisms to the SEC.

“I don’t think that there was an organized movement. I think that these were 30 fund groups acting independently,” Seip said. “I also think that I spoke to someone at the IDC about this, and she mentioned that she’d had a number of conversations with fund chairs and fund counsel about these rules, and so from that conversation I knew that there was a lot of interest here.”

While boards did not coordinate with each other per se before deciding to comment, interactions like these convinced many that they would be in good company when speaking out.

“Since we don’t usually do this, I think it’s fair to say that a board didn’t want to be out there by themselves,” said an independent chair whose board submitted a comment letter and who asked to remain unnamed. “As people talked and met at meetings and things like that, directors talked about the fact that their board was considering it, and you got [comfortable with the idea] that, you know what, there’s nothing wrong with doing this.”

The future of board comments

Public comments are the most visible source of input and opposition to SEC regulations, but the industry continues to push the SEC on the swing-pricing proposal, using individual and group meetings, correspondence and public speeches at industry gatherings as their primary media, according to speakers and attendees at this month’s ICI Investment Management Conference in Palm Desert, Calif.

It remains to be seen whether the language of the proposal or the SEC’s intentions will shift based on that opposition and the mobilization of the board community.

Some members of that community also wonder, however, whether breaking their collective silence for the first time may have caused boards themselves to change as well.

“For fund boards, you sort of have a basic conversation about, ‘Is this an activity we want to engage in?’ And clearly for a lot of boards, they’ve said no [to commenting on regulation] up until now,” Hamacher said. “And now they’ve said yes.”

Unlike many of the respondents to the swing pricing proposal, Hamacher is no stranger to writing public comments. She has submitted comment letters in her own name as far back as 2004, and in 2020, her fund board was the only one to submit a comment letter responding to the SEC’s proposed updates to fund shareholder reports, which were finalized in late 2022.

With so many boards now acknowledging that certain issues can draw them into public discourse, trustees may feel more comfortable commenting the next time the SEC comes out with a controversial proposal, Hamacher said.

“They’ve had that conversation now, and so you don’t have to repeat that. You just have to repeat, ‘Given what we decided last time, is this new proposal meeting the criteria we established?’” Hamacher said. “I’d say the odds are probably higher that you see more director comments.”

Much of that depends on the SEC’s approach to future rulemaking, she added.

Currently, nobody is quite sure what long-term effects the swing pricing comment period will have on the relationship between fund boards and their regulator, but the industry is hoping that the SEC will heed their demands and withdraw the proposal, according to MFDF president Carolyn McPhillips.

“In my dream world, this rule would go away and we would never see it again,” she said.

Kevin Fogarty contributed reporting.