Fidelity Investments Chairman and Chief Executive Ned Johnson urged in a letter posted on the company’s Web site that the industry create a central clearinghouse to process mutual fund trades so it can prevent illegal after-hours dealing.
To be overseen by government regulators, the clearinghouse would allow fund companies to track an order back to the individual making it, which Johnson claimed fund companies can’t now do under omnibus accounts and will not be able to do by shutting off trades at 4 p.m. “If trades can be traced back to their source, it will be far more difficult for disruptive traders or arbitrageurs to hide,” the Fidelity executive wrote.
According to Johnson’s view, the clearinghouse would represent a point of control administered by an independent third party open to inspection by regulators and the industry. To ensure compliance with the daily 4 p.m. pricing cutoff, a uniform time stamping methodology with supporting technology would be deployed. Only orders meeting the defined cutoff would be processed at that day’s prices, Johnson said. Orders would be considered “locked” when time-stamped, and any orders received after 4 p.m. would be rejected, except for legitimate error correction subject to appropriate review. A central logging, monitoring and reporting function would keep track of all trades.
“With such a system in place, it would be very difficult to execute a trade that was ordered after the market close because there always would be a check on the time stamp,” Johnson argued in the letter .
The Fidelity official also argued that virtually everyone to touch a trade should have to assume a measure of responsibility for it. “We would suggest including in the clearinghouse procedures the assignment of fiduciary responsibility to anyone and everyone touching a trade at any point in its execution,” he said. “This would apply to intermediaries such as banks, insurance companies, and investment advisors, which would be required to take legal responsibility for all trades they submit.”
A Hard Close
The proposal to establish a central clearinghouse contrasts with the approach proposed by the US Securities and Exchange Commission (SEC) on December 3 (See SEC Lays Down Mutual Fund Proposals ). Under the SEC plan, investors would have to get all their orders to fund companies before the 4 p.m. deadline. Now, brokers can send in orders later and are supposed to ensure that only trades received before the deadline are submitted. The SEC plan’s so-called hard close might not stop frequent trading abuses because trades could still be submitted in batches, Johnson said.
In terms of market timing, Johnson said the fund industry “must do even more to make certain that all of the promises made to investors in a fund’s prospectus are strictly adhered to. For example, fair value pricing methodology could be strengthened, and short-term redemption fees could be beefed up and applied to those funds that are targets of market timers.”
According to New York State Attorney General Eliot Spitzer, a central figure in the fund scandal, some hedge funds were able to avoid the fund industry’s deadline of 4 p.m. New York time by placing trades through brokerage firms and retirement-plan administrators (See Spitzer Fund Abuse Probe Pumps Out More Subpoenas ). Mutual funds are priced once a day even though the securities they own trade continuously around the world. To keep all investors on an even playing field, federal law requires that trades submitted after 4 p.m. receive the next day’s price. Fidelity has said it responded to requests for information about its trading practices from Spitzer and the SEC.
Johnson warned against the dangers of overregulating as a response to the scandal.
“We don’t need unnecessary regulations. What is called for is a fine-tuning and adjustment of existing regulations governing this industry to ensure that they fit today’s Internet Age – that they are wise and practical, can be enforced both by the government and the mutual fund companies, and above all are good for America’s mutual fund shareholders,” Johnson argued. “Let us find and deal appropriately with those who have broken the law. That goes for Fidelity Investments or any other company. But let us also be sure that when we update the rules and regulations that govern the mutual fund industry, we do so wisely and with common sense. Congress must make certain it is informed about the intricacies of the entire mutual fund industry not just one part of the business to ensure that it is not tempted to regulate based on the siren-song of self-interested individuals and groups.”
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