MARKET TIMING AND OTHER TRADING ABUSES



Beginning in the summer of 2003, the SEC and several State Attorney Generals initiated investigations into improper market timing and late trading by a number of mutual fund complexes. These investigations led to more than 30 Federal and state enforcement actions against certain mutual funds and their advisers for permitting improper arbitrage activities and accepting trading orders after the 4 PM close of the New York stock and bond exchanges. 

 

The SEC and State regulators collected as much as $3.5 billion in penalties and fines from these mutual fund companies and the SEC is in the process of distributing these restitution monies to the investors aggrieved by improper market timing activities.   

 

Excessive short-term trading activities in a mutual fund can cause a dilution in the value of the shares for long-term investors in the same fund. The excess profits taken by market timers in a fund reduce the capital appreciation for investors who are transacting in fund shares over a longer time horizon.

 

The lack of transparency within broker-dealer omnibus accounts was identified as a significant issue in the inability of mutual funds to identify and deter inappropriate short-term trading of fund shares. As stated by the Chairman of the Investment Company Institute in testimony on March 31, 2004: "A particular challenge that funds face in effectively implementing restrictions on short-term trading is that many fund investments are held in omnibus accounts maintained by an intermediary (e.g., a broker-dealer or a retirement plan record keeper).  Often in those cases, the fund cannot monitor trading activity by individual investors in these accounts.  Steps clearly need to be taken to enable mutual funds to enforce more effectively restrictions they establish on short-term trading when such trading takes place through omnibus accounts." 

 

In response to this problem, the SEC adopted Rule 22c-2, requiring mutual funds to have written agreements with all of their financial intermediaries, in order to facilitate information-sharing at the individual investor level. Rule 22c-2 requires an intermediary to provide shareholder identification and transaction information for any or all of its customers at the request of a mutual fund.

 

Unfortunately, mutual funds are not using this information-sharing tool and instead are relying on their financial intermediaries to detect market timing activities and enforce other policies in each fund's prospectus. To provide a solution to this problem, CMFI has advocated that the SEC amend Rule 22c-2, in order to provide for full transparency of investor-level information within omnibus accounts, on a real-time basis. Under this approach, mutual funds would be able to enforce market timing and short-term trading policies in a uniform and cost-effective manner for all investors.

 

The SEC has not yet changed Rule 22c-2, even though there is evidence that market timing and other arbitrage activities still occur in certain international, small cap, and bond funds. 

 

Click on the tabs for Documents, Comments, and Blog Entries to review the latest developments on market timing activities within omnibus accounts.

  • SEC Letter in Response to CMFI White Paper on Risks in Hidden Shareholder Accounts
    On June 23, 2009, SEC Chairman Mary Schapiro sent a letter in response to the CMFI White Paper on the market timing and other risks inherent in hidden mutual fund accounts.
  • CMFI Letter to SEC Chairman Mary Schapiro on Market Timing and Other Risks in Hidden Shareholder Accounts
    On May 6, 2009, CMFI sent a letter to the SEC enclosing a White Paper on the risks to long-term shareholders of hidden mutual fund accounts.
  • CMFI White Paper on Market Timing and Other Risks in Hidden Shareholder Accounts
    On March 30, 2009, CMFI issued a White Paper on the risks to long-term shareholders of hidden mutual fund accounts.
  • SEC Response to CMFI 2007 Study on Short-Term Trading Policies of Largest Mutual Fund Groups
    On August 20, 2007, the SEC sent a letter to CMFI, in response to CMFI's 2007 study of the short-term trading policies of the 50 largest mutual fund groups. This SEC letter expressed appreciation for CMFI's work on the issue of omnibus accounts, noting that CMFI's comment letters and studies have contributed greatly to the agency's understanding of the impact of market timing on mutual fund investors and to SEC development of Rule 22c-2.
  • CMFI Letter to SEC Chairman Christopher Cox on CMFI 2007 Short-Term Trading Study
    On June 26, 2007, CMFI sent a letter to SEC Chairman Christopher Cox, transmitting a copy of the CMFI 2007 study evaluating the short-term trading policies of the 50 largest mutual fund groups.
  • CMFI Press Release on 2007 Study of Short-Term Trading Policies of Largest Fund Groups
    On June 20, 2007, CMFI issued a press release with its third study on the short-term trading policies of the 50 largest mutual fund groups. The study concluded that it is impossible for mutual funds to enforce their excessive trading policies because of a lack of transparency in omnibus accounts held by broker-dealers and other third-party financial intermediaries.
  • Final SEC Redemption Fee Rule
    On September 27, 2006, the SEC issued its final rule on mutual fund redemption fees.
  • CMFI Comment Letter on Proposed Amendments to the SEC Redemption Fee Rule
    On April 10, 2006, CMFI submitted a comment letter in response to the SEC’s proposed amendments to its redemption fee rule.
  • Proposed Amendments to the SEC Redemption Fee Rule
    On February 28, 2006, the SEC proposed several amendments to its recently adopted redemption fee rule. The rule, among other provisions, requires most mutual funds to enter into agreements with financial intermediaries (e.g. broker-dealers) that hold shares on behalf of other investors in omnibus accounts. These agreements must provide funds access to information about transactions in these accounts to enable the funds to enforce restrictions on market timing and other abusive transactions. The SEC seeks to amend the rule to clarify its operation and reduce the number of intermediaries with which funds must negotiate information-sharing agreements. The amendments are designed to address issues that came to the SEC’s attention after it adopted the final version of the rule, and are designed to reduce the costs to funds (and fund shareholders) while still achieving the goals of the rulemaking.
  • CMFI Comment Letter on SEC Redemption Fee Rule
    On May 9, 2005, CMFI submitted additional comments on the SEC’s redemption fee rule.
  • CMFI Letter to SEC Chairman Donaldson on 2005 Market Timing Study
    On May 6, 2005, CMFI sent a letter to SEC Chairman William Donaldson, transmitting a copy of its 2005 study on the market timing policies of the 50 largest mutual fund groups.
  • CMFI Press Release on 2005 Market Timing Study
    On May 5, 2005, CMFI issued a press release explaining the results of its 2005 study examining the 50 largest fund groups on their use of redemption fees and other mutual fund policies aimed at deterring short-term trading. The study found that it is impossible for mutual funds to effectively enforce their policies because many of their customers are concealed in third-party omnibus accounts.
  • SEC Final Rule on Mutual Fund Redemption Fees
    On March 11, 2005, the SEC issued its final rule on mutual fund redemption fees. Under the final rule, mutual funds are authorized, but not required, to impose redemption fees to address market timing and other short-term trading abuses. The SEC also requested additional comment on several outstanding issues.
  • Senator Peter Fitzgerald Praises CMFI Study on Market Timing Issues
    On August 4, 2004, U.S. Senator Peter Fitzgerald (R-IL) issued a press release in favor of the CMFI 2004 study on the market timing policies of the mutual fund industry. This study examined the redemption fee and market timing policies of the 50 largest mutual fund groups. The study concluded that these fund groups are unable to monitor or regulate market timing activities in omnibus accounts, which are shareholder accounts held by third-party financial institutions. The results of this study demonstrate the need for full transparency regarding the identities and trading activities of third-party omnibus accounts. Senator Fitzgerald has introduced mutual fund reform legislation to address this issue.
  • CMFI Comment Letter on the SEC Mandatory Redemption Fee Proposal
    On May 10, 2004, CMFI submitted a comment letter in response to the SEC’s proposed rule to require mutual funds to impose a mandatory redemption fee.
  • SEC Final Rule on Market Timing Abuses
    On April 19, 2004, the SEC issued its final rule on market timing abuses. The final rule requires mutual funds to disclose in their prospectuses both the risks to shareholders of frequent purchases and redemptions of fund shares, and the mutual fund’s policies and procedures with respect to such frequent purchases and redemptions. The SEC’s rule also requires similar prospectus disclosure for insurance company separate accounts issuing variable annuity and variable life insurance contracts. Both mutual funds and insurance company separate accounts are required to explain both the circumstances under which they will use fair value pricing and the effects of using fair value pricing. Finally, the SEC rule requires mutual funds and insurance company separate accounts to disclose both their policies and procedures with respect to the disclosure of their portfolio securities, and any ongoing arrangements to make available information about their portfolio securities.
  • Proposed SEC Mandatory Redemption Fee Rule
    On March 5, 2004, the SEC proposed a rule to require mutual funds (with certain limited exceptions) to impose a two percent (2%) redemption fee on the redemption of shares purchased within the previous five (5) days. The redemption fee would be retained by the fund and its shareholders. The proposed rule is designed to require transient shareholders to reimburse the mutual fund for costs incurred when they use the fund to implement short-term trading strategies, such as market timing. The rule also requires that financial intermediaries using omnibus accounts share information with mutual funds about the identities and transactions of their customers within those accounts.
  • CMFI Comment Letter on Proposed SEC Market Timing Rule
    On February 6, 2004, CMFI submitted a comment letter on the SEC’s proposed market timing rule. In its comment letter, CMFI expressed support for the SEC’s proposed disclosure regime and urged that each mutual fund be permitted to monitor market timing and other trading abuses within omnibus accounts through an SEC requirement that fund intermediaries disclose investor identity and transaction information within these accounts.
  • CMFI Comment Letter on Proposed SEC Late Trading Rule
    On February 6, 2004, CMFI submitted a comment letter on the SEC’s proposed late trading rule. In its comment letter, CMFI supported the SEC’s proposal to implement a 4:00 PM firm deadline for mutual fund orders to be received, instead of permitting transactions to be submitted after 4:00 PM by fund intermediaries.
  • SEC Proposed Rule on Market Timing Abuses
    On December 11, 2003, the SEC issued a proposed rule requiring mutual funds to disclose in their prospectuses: (1) the risks to shareholders of the frequent purchase and redemption of fund shares; and (2) the mutual fund’s policies and procedures with respect to such frequent purchases and redemptions. The SEC proposal would require similar prospectus disclosure for insurance company separate accounts issuing variable annuity and variable life insurance contracts. The SEC proposal also clarifies that mutual funds and insurance company separate accounts are required to explain both the circumstances under which they will use fair value pricing and the effects of fair value pricing. In addition, the SEC is proposing to require mutual funds and insurance company separate accounts to disclose their policies and procedures with respect to the disclosure of their portfolio securities, and any ongoing arrangements to make available information about their portfolio securities.
  • SEC Proposed Rule on Late Trading Abuses
    On December 11, 2003, the SEC issued a proposed rule to restrict trading in mutual fund shares after the markets close at 4:00 PM Eastern Time. Under the SEC’s proposal, an order to purchase or redeem mutual fund shares would receive the current day’s price only if the fund, its designated transfer agent, or a registered securities clearing agency receives the order by the time that the fund establishes for calculating its net asset value. This time is typically when the major U.S. stock exchanges close at 4:00 PM Eastern Time. The SEC’s proposal is designed to prevent unlawful late trading in mutual fund shares.
  • good info!
    20 September, 2011

    good info!

Beginning in the summer of 2003, the SEC and several State Attorney Generals initiated investigations into improper market timing and late trading by a number of mutual fund complexes. These investigations led to more than 30 Federal and state enforcement actions against certain mutual funds and their advisers for permitting improper arbitrage activities and accepting trading orders after the 4 PM close of the New York stock and bond exchanges. 

 

The SEC and State regulators collected as much as $3.5 billion in penalties and fines from these mutual fund companies and the SEC is in the process of distributing these restitution monies to the investors aggrieved by improper market timing activities.   

 

Excessive short-term trading activities in a mutual fund can cause a dilution in the value of the shares for long-term investors in the same fund. The excess profits taken by market timers in a fund reduce the capital appreciation for investors who are transacting in fund shares over a longer time horizon.

 

The lack of transparency within broker-dealer omnibus accounts was identified as a significant issue in the inability of mutual funds to identify and deter inappropriate short-term trading of fund shares. As stated by the Chairman of the Investment Company Institute in testimony on March 31, 2004: "A particular challenge that funds face in effectively implementing restrictions on short-term trading is that many fund investments are held in omnibus accounts maintained by an intermediary (e.g., a broker-dealer or a retirement plan record keeper).  Often in those cases, the fund cannot monitor trading activity by individual investors in these accounts.  Steps clearly need to be taken to enable mutual funds to enforce more effectively restrictions they establish on short-term trading when such trading takes place through omnibus accounts." 

 

In response to this problem, the SEC adopted Rule 22c-2, requiring mutual funds to have written agreements with all of their financial intermediaries, in order to facilitate information-sharing at the individual investor level. Rule 22c-2 requires an intermediary to provide shareholder identification and transaction information for any or all of its customers at the request of a mutual fund.

 

Unfortunately, mutual funds are not using this information-sharing tool and instead are relying on their financial intermediaries to detect market timing activities and enforce other policies in each fund's prospectus. To provide a solution to this problem, CMFI has advocated that the SEC amend Rule 22c-2, in order to provide for full transparency of investor-level information within omnibus accounts, on a real-time basis. Under this approach, mutual funds would be able to enforce market timing and short-term trading policies in a uniform and cost-effective manner for all investors.

 

The SEC has not yet changed Rule 22c-2, even though there is evidence that market timing and other arbitrage activities still occur in certain international, small cap, and bond funds. 

 

Click on the tabs for Documents, Comments, and Blog Entries to review the latest developments on market timing activities within omnibus accounts.

Document Title: 
SEC Letter in Response to CMFI White Paper on Risks in Hidden Shareholder Accounts
Document Desc: 
On June 23, 2009, SEC Chairman Mary Schapiro sent a letter in response to the CMFI White Paper on the market timing and other risks inherent in hidden mutual fund accounts.
Document Title: 
CMFI Letter to SEC Chairman Mary Schapiro on Market Timing and Other Risks in Hidden Shareholder Accounts
Document Desc: 
On May 6, 2009, CMFI sent a letter to the SEC enclosing a White Paper on the risks to long-term shareholders of hidden mutual fund accounts.
Upload Document: 
Document Title: 
CMFI White Paper on Market Timing and Other Risks in Hidden Shareholder Accounts
Document Desc: 
On March 30, 2009, CMFI issued a White Paper on the risks to long-term shareholders of hidden mutual fund accounts.
Upload Document: 
Document Title: 
SEC Response to CMFI 2007 Study on Short-Term Trading Policies of Largest Mutual Fund Groups
Document Desc: 
On August 20, 2007, the SEC sent a letter to CMFI, in response to CMFI's 2007 study of the short-term trading policies of the 50 largest mutual fund groups. This SEC letter expressed appreciation for CMFI's work on the issue of omnibus accounts, noting that CMFI's comment letters and studies have contributed greatly to the agency's understanding of the impact of market timing on mutual fund investors and to SEC development of Rule 22c-2.
Upload Document: 
Document Title: 
CMFI Letter to SEC Chairman Christopher Cox on CMFI 2007 Short-Term Trading Study
Document Desc: 
On June 26, 2007, CMFI sent a letter to SEC Chairman Christopher Cox, transmitting a copy of the CMFI 2007 study evaluating the short-term trading policies of the 50 largest mutual fund groups.
Document Title: 
CMFI Press Release on 2007 Study of Short-Term Trading Policies of Largest Fund Groups
Document Desc: 
On June 20, 2007, CMFI issued a press release with its third study on the short-term trading policies of the 50 largest mutual fund groups. The study concluded that it is impossible for mutual funds to enforce their excessive trading policies because of a lack of transparency in omnibus accounts held by broker-dealers and other third-party financial intermediaries.
Upload Document: 
Document Title: 
Final SEC Redemption Fee Rule
Document Desc: 
On September 27, 2006, the SEC issued its final rule on mutual fund redemption fees.
Document Title: 
CMFI Comment Letter on Proposed Amendments to the SEC Redemption Fee Rule
Document Desc: 
On April 10, 2006, CMFI submitted a comment letter in response to the SEC’s proposed amendments to its redemption fee rule.
Document Title: 
Proposed Amendments to the SEC Redemption Fee Rule
Document Desc: 
On February 28, 2006, the SEC proposed several amendments to its recently adopted redemption fee rule. The rule, among other provisions, requires most mutual funds to enter into agreements with financial intermediaries (e.g. broker-dealers) that hold shares on behalf of other investors in omnibus accounts. These agreements must provide funds access to information about transactions in these accounts to enable the funds to enforce restrictions on market timing and other abusive transactions. The SEC seeks to amend the rule to clarify its operation and reduce the number of intermediaries with which funds must negotiate information-sharing agreements. The amendments are designed to address issues that came to the SEC’s attention after it adopted the final version of the rule, and are designed to reduce the costs to funds (and fund shareholders) while still achieving the goals of the rulemaking.
Document Title: 
CMFI Comment Letter on SEC Redemption Fee Rule
Document Desc: 
On May 9, 2005, CMFI submitted additional comments on the SEC’s redemption fee rule.
Document Title: 
CMFI Letter to SEC Chairman Donaldson on 2005 Market Timing Study
Document Desc: 
On May 6, 2005, CMFI sent a letter to SEC Chairman William Donaldson, transmitting a copy of its 2005 study on the market timing policies of the 50 largest mutual fund groups.
Document Title: 
CMFI Press Release on 2005 Market Timing Study
Document Desc: 
On May 5, 2005, CMFI issued a press release explaining the results of its 2005 study examining the 50 largest fund groups on their use of redemption fees and other mutual fund policies aimed at deterring short-term trading. The study found that it is impossible for mutual funds to effectively enforce their policies because many of their customers are concealed in third-party omnibus accounts.
Document Title: 
SEC Final Rule on Mutual Fund Redemption Fees
Document Desc: 
On March 11, 2005, the SEC issued its final rule on mutual fund redemption fees. Under the final rule, mutual funds are authorized, but not required, to impose redemption fees to address market timing and other short-term trading abuses. The SEC also requested additional comment on several outstanding issues.
Upload Document: 
Document Title: 
Senator Peter Fitzgerald Praises CMFI Study on Market Timing Issues
Document Desc: 
On August 4, 2004, U.S. Senator Peter Fitzgerald (R-IL) issued a press release in favor of the CMFI 2004 study on the market timing policies of the mutual fund industry. This study examined the redemption fee and market timing policies of the 50 largest mutual fund groups. The study concluded that these fund groups are unable to monitor or regulate market timing activities in omnibus accounts, which are shareholder accounts held by third-party financial institutions. The results of this study demonstrate the need for full transparency regarding the identities and trading activities of third-party omnibus accounts. Senator Fitzgerald has introduced mutual fund reform legislation to address this issue.
Document Title: 
CMFI Comment Letter on the SEC Mandatory Redemption Fee Proposal
Document Desc: 
On May 10, 2004, CMFI submitted a comment letter in response to the SEC’s proposed rule to require mutual funds to impose a mandatory redemption fee.
Document Title: 
SEC Final Rule on Market Timing Abuses
Document Desc: 
On April 19, 2004, the SEC issued its final rule on market timing abuses. The final rule requires mutual funds to disclose in their prospectuses both the risks to shareholders of frequent purchases and redemptions of fund shares, and the mutual fund’s policies and procedures with respect to such frequent purchases and redemptions. The SEC’s rule also requires similar prospectus disclosure for insurance company separate accounts issuing variable annuity and variable life insurance contracts. Both mutual funds and insurance company separate accounts are required to explain both the circumstances under which they will use fair value pricing and the effects of using fair value pricing. Finally, the SEC rule requires mutual funds and insurance company separate accounts to disclose both their policies and procedures with respect to the disclosure of their portfolio securities, and any ongoing arrangements to make available information about their portfolio securities.
Document Title: 
Proposed SEC Mandatory Redemption Fee Rule
Document Desc: 
On March 5, 2004, the SEC proposed a rule to require mutual funds (with certain limited exceptions) to impose a two percent (2%) redemption fee on the redemption of shares purchased within the previous five (5) days. The redemption fee would be retained by the fund and its shareholders. The proposed rule is designed to require transient shareholders to reimburse the mutual fund for costs incurred when they use the fund to implement short-term trading strategies, such as market timing. The rule also requires that financial intermediaries using omnibus accounts share information with mutual funds about the identities and transactions of their customers within those accounts.
Document Title: 
CMFI Comment Letter on Proposed SEC Market Timing Rule
Document Desc: 
On February 6, 2004, CMFI submitted a comment letter on the SEC’s proposed market timing rule. In its comment letter, CMFI expressed support for the SEC’s proposed disclosure regime and urged that each mutual fund be permitted to monitor market timing and other trading abuses within omnibus accounts through an SEC requirement that fund intermediaries disclose investor identity and transaction information within these accounts.
Document Title: 
CMFI Comment Letter on Proposed SEC Late Trading Rule
Document Desc: 
On February 6, 2004, CMFI submitted a comment letter on the SEC’s proposed late trading rule. In its comment letter, CMFI supported the SEC’s proposal to implement a 4:00 PM firm deadline for mutual fund orders to be received, instead of permitting transactions to be submitted after 4:00 PM by fund intermediaries.
Upload Document: 
Document Title: 
SEC Proposed Rule on Market Timing Abuses
Document Desc: 
On December 11, 2003, the SEC issued a proposed rule requiring mutual funds to disclose in their prospectuses: (1) the risks to shareholders of the frequent purchase and redemption of fund shares; and (2) the mutual fund’s policies and procedures with respect to such frequent purchases and redemptions. The SEC proposal would require similar prospectus disclosure for insurance company separate accounts issuing variable annuity and variable life insurance contracts. The SEC proposal also clarifies that mutual funds and insurance company separate accounts are required to explain both the circumstances under which they will use fair value pricing and the effects of fair value pricing. In addition, the SEC is proposing to require mutual funds and insurance company separate accounts to disclose their policies and procedures with respect to the disclosure of their portfolio securities, and any ongoing arrangements to make available information about their portfolio securities.
Document Title: 
SEC Proposed Rule on Late Trading Abuses
Document Desc: 
On December 11, 2003, the SEC issued a proposed rule to restrict trading in mutual fund shares after the markets close at 4:00 PM Eastern Time. Under the SEC’s proposal, an order to purchase or redeem mutual fund shares would receive the current day’s price only if the fund, its designated transfer agent, or a registered securities clearing agency receives the order by the time that the fund establishes for calculating its net asset value. This time is typically when the major U.S. stock exchanges close at 4:00 PM Eastern Time. The SEC’s proposal is designed to prevent unlawful late trading in mutual fund shares.