May 31, 2007

Scaring the little guy

(c) View From Silicon Valley, 2007.  All rights reserved.



The stock market continues to make new highs on a near-daily basis.  It seems every day brings a new rationale "why" the bull will continue.  One day it's the Fed model.  The next it's Alan Greenspan claiming to know the Shanghai market has another couple thousand points to go.  Then it's the "proven fact" new all-time highs in short interest will support the market.

Hussman, Ritholtz and others are, thankfully, refuting these arguments as specious, statistically invalid and/or based on wishful thinking.  Inevitably, another set of "spin" will follow. 

One claim which might soon be up for it's turn as "spin of the day" is lack of participation by the "little guy."  Surely, once the "little guy" gets on board, we will see more new highs, right?

A recent form letter received from my broker is interesting for a couple reasons, not least of which is potential relevance for the "little guy." 

If a lot of these letters are going out, could it help explain why the "little guy" is not "participating"?  Interestingly, this letter speaks to a whole level of chutzpah we'll highlight in a moment.

First the letter:
* * * * *
Our records show you purchased XXXXX (mutual fund) on 3/13/2007 and redeemed or exchanged it on 5/1/2007. Because of the short-term nature of the holding period, we felt it appropriate to inform you about restrictions on short-term mutual fund trading.

Short-term mutual fund trading refers to buying and selling a mutual fund within a short time frame. Most mutual funds are designed to be long-term investments and have requirements stated in their prospectuses on how long they must be held. The securities industry takes the issue of short-term trading very seriously, as excessive trading can be detrimental to a fund’s performance (Ref. NASD Rule 2110 and IM-2310-2(3)).

Mutual fund companies that determine a customer has violated the short-term trading rule can force us to restrict further purchases. They may also permanently block the customer from making future purchases in their family of funds through any brokerage firm.

Please understand that XXXX (brokerage) is bound by the rules, regulations and practices of the NASD and the brokerage industry and must conduct due diligence in deterring short-term trading in mutual funds. Therefore, we feel it important to send this information letter to make sure that your account is not restricted in the future.

Hopefully, this information will assist in clarifying short-term trading requirements. If you have any questions or need further details, please feel free to call your local branch.

Sincerely,
XXXX
* * * * *
Whoa!  This sets me off on a number of fronts.

For the record, my brokerage charges a $17 "fee" charged to sell mutual fund shares.  Funds held less than 180 days are charged an extra $17.00 which was less than one tenth of one percent of the transaction.  I bet it cost most of that $17.00 to generate, mail and keep a record of the letter.  Probably more than $17.00 after I call and complain.  (A lot more if I get just a little more irritated and move money to a different broker...)

After all:

1) There was nothing in the prospectus for this government bond fund about "how long (the shares) must be held."

2) This was just a simple "intermediate term" no load bond fund.  There was no leverage nor any complex long-short positions to be unwound.  The strategy was to capture a little interest income, and maybe a couple pennies capital appreciation, with minimal risk.  I held it seven weeks which clearly does not violate any common definition of "short-term" or "excessive" trading from something as simple as a no load, straight-up government bond fund.

3) How would, or could, this bond fund would really cut someone off?  What if the person they try to cut off still holds shares in the same fund?  Would they presume to "force" me to sell off the rest of their shares?  (If so, wouldn't this compound the alleged "churn"?!?)

4) If I was actually cut-off from buying this fund, who cares?  There are easily 39 (or whatever the latest figure) bond funds with similar strategies and results.

5) Are we supposed to be initimidated by the reference to NASD Rule 2110 and IM-2310-2(3)?  Are they trying to imply it's suddenly illegal to sell your mutual fund?