SEC to Consider Post-Canary Scandal Trading Reforms

October 10, 2003 ( - With investigations continuing into mutual fund trading abuses, the US Securities and Exchange Commission (SEC) will consider a menu of reforms including requiring a fund - not intermediaries - to receive trades before the fund sets that day's prices.

In announcing that the SEC would consider the reforms no later than by November, Chairman William Donaldson said one proposal would require that fund officials (rather than an intermediary such as a broker-dealer) have to have trades in hand before the fund sets that day’s price (typically 4 p.m. Eastern time). This would effectively eliminate the potential for late trading through intermediaries that sell fund shares, Donaldson pointed out.

Another suggestion is to require fund managers have additional procedures and controls to prevent late trading and ensure compliance with the new pricing requirements.

The SEC is likewise looking into whether funds need more tools to thwart market timing and whether additional requirements are necessary to reinforce funds’ and advisers’ obligations to comply with their fiduciary duties and to prevent the misuse of non-public information, including the selective disclosure of portfolio holdings information, Donaldson said in a statement.

Even though much of the public focus has been on the ongoing fund trading practices probe by   New York Attorney General Eliot Spitzer, Donaldson said that the SEC continues its own examination to not only punish those convicted of crimes, but to get money back for shareholders.   “Our staff is aggressively investigating these allegations and is committed to holding those responsible for violating the federal securities laws accountable and seeking restitution for mutual fund investors that have been harmed by these abuses,” the SEC official said.

Last month, Spitzer announced a settlement with Canary Capital Management, a hedge fund that allegedly engaged in late trading and market timing with four mutual fund companies, Bank of America Corp. Banc One Corp., Janus Capital Group Inc., and Strong Capital Management.  Canary and its managers agreed to pay $30 million in restitution for profits generated from improper trading, plus a $10-million penalty to settle Spitzer’s allegations (See  Spitzer Fund Abuse Probe Pumps Out More Subpoenas  ).

For example, Bank of America was accused of having a trader who had an agreement with Canary to trade funds at the 4 o’clock prices hours after the market closed. That allowed Canary to cash in on after-hours news ahead of other investors, who at that hour would be forced to chance buying at the next day’s closing price.

Late trading in mutual funds – which refers to trades made after the market closes – is illegal. Market timing isn’t, although most mutual funds have policies to prevent it, which involves rapid buying and selling of fund shares depending on the movement of the markets.

New Proposed Rules

According to Donaldson, the SEC is also pondering new rules to curb market-timing abuses, including:

  • requiring explicit disclosure in fund offering documents of market-timing policies and procedures
  • reinforcing the obligation of fund directors to consider the adequacy and effectiveness of fund market timing practices and procedures
  • emphasizing the obligation of funds to fair value their securities under certain circumstances to minimize market timing arbitrage opportunities.

Several of the firms involved – including Janus and Bank of America – have pledged to make restitution to investors in mutual funds who lost money because of alleged improper trading (See    Bank of America Will Pay Restitution to Mutual Fund Holders ). Also, investors pulled $4.4 billion out of Janus funds in September, most of it after questions were raised about the company’s trading practices, according to news reports.

A number of the firms kicked off their own in-house trading practices investigations (See Ripples of Canary Fund Trading Probes Continue to Spread ).