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Hold Those Shares -- Or Else


Many mutual-fund shareholders and 401(k) investors are getting surprising news in the mail: Hold on to your fund shares once you buy them, or you'll be hit with fees of up to 2% when you sell. Since the start of last year, fund-watcher Lipper (RTRSY) says, 1,140 mutual funds have added such redemption fees, imposed when investors sell shares they've bought within the last 5, 30, or even 90 days. In some cases, shareholders will be charged even if they sell within a year -- a long time to be locked in to an investment.

Funds are taking their cue from the Securities & Exchange Commission, which views redemption fees as one way to clean up trading abuses exposed in the mutual-fund scandals. The SEC is mulling a rule that would require most funds to charge a 2% fee on shares sold within five days of purchase. That would combat market timing, the legal -- but abusive -- practice of moving rapidly in and out of a fund to take advantage of outdated prices on foreign or thinly traded small-company stocks.

HIGHER HURDLES. But lock-in periods don't allow investors to respond quickly to sudden swings in the market except by paying a fee. "It's the little investor who will get squeezed," says Warren W. Wall, president of W. Wall & Co., an Asheville (N.C.) investment-adviser firm that manages $50 million, mostly for retirees. By contrast, he argues, big investors who want to time the market can reap profits that far exceed the 2% fee for rapid trading.

The SEC's proposed five-day holding period isn't too onerous -- but most of the new fees are imposed for sales within far longer periods. Says Don Phillips, managing director of fund tracker Morningstar Inc: "The SEC has sent a signal to fund companies that's allowing them to set hurdles that are higher."

Some large 401(k) retirement plans are following suit with their own limits on how often participants can move money around. The SEC proposal also would let funds waive fees when investors cash out in an emergency or withdraw $2,500 or less. Few of the funds that impose fees offer such outs.

The list of those adding fees is heavy with global and small-cap stock funds, where stale pricing can be a problem. But it also includes domestic equity funds that don't give any scope for market timing. In January, for example, the Oakmark Fund (OAKMX), which invests in big U.S. companies, and Oakmark Equity & Income Fund (OAKBX), a mid- to large-cap stock-and-bond fund, started charging 2% on shares held less than 90 days, the same fee it levies on five other funds. "We didn't see any evidence of timing in [the two funds], but we thought it would be prudent to institute redemption fees across all our funds," an Oakmark Family of Funds spokeswoman says.

THE LONG VIEW. While they're spreading rapidly, redemption fees are nothing new. Industry execs defend them, arguing that mutual funds are supposed to be long-term investments and fees help keep out short-term investors. The fees, which are reinvested in the funds, are meant to protect long-term holders by charging traders for the costs the funds incur. That's why low-cost fund purveyor Vanguard Group imposes some of the most onerous redemption fees in the industry. Its tax-managed funds charge 2% on shares redeemed within one year and 1% on redemptions within the next four years. Jeff Molitor, director of portfolio review at Vanguard, is unapologetic: "We want longer-term investors in these funds -- it's easier and cheaper to manage."

Employers, too, are trying to deter active traders in their 401(k) plans. General Motors Corp. (GM) assesses a 1% fee on redemptions within 30 days in some international funds in its retirement plan. AT&T (T) employees pay 1% to 1.5% if they sell holdings in the 401(k) plan's international funds within 30 to 90 days of buying them. Critics fret that such restrictions are eerily similar to the prohibition on the sale of Enron Corp. stock in the company's 401(k) plans that destroyed the retirement savings of thousands of its workers when the share price collapsed.

For years, funds have had the right to impose redemption fees, but many didn't because the charges would put them at a competitive disadvantage. Now that they're getting the green light from the SEC, funds are seizing the opportunity. By Amy Borrus in Washington, with Steve Rosenbush in New York


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