Late for work? Tell your boss that the train was delayed and she'll commiserate. Late sending out your mother's birthday card? Blame it on the mailman and she'll be cooking your favorite meal again. Late trading a mutual-fund? Take a short trip out the door of your firm, down the street to unemployment, and possibly enjoy a vacation in jail in between.
Late trading mutual funds after the market's close, with the purpose of receiving that day's market price, has been widely reported. Because it offers more timely quotes than those available at the market's close, it violates the mandate that all shareholders in the fund be treated equally.
Suggestions on the table to combat the practice include a hard cutoff of 4 p.m. for trades to arrive at mutual funds, enhancements to the clearance and settlement systems, and greater transparency between mutual funds and intermediaries.
While each solution varies in its scale and depth, one thing is guaranteed: Technology is the weapon that will enable Wall Street to win its battle against late trading.
THE MAGIC HOUR
A Securities and Exchange Commission proposal requires that "an order to purchase or redeem mutual-fund shares be received by the mutual fund - or its primary transfer agent or a registered-securities-clearing agency" by 4 p.m. In the past, orders were required only to have been placed by the shareholder by that time.
While the 4 p.m. mutual-fund deadline seems to be the most logical resolution at a glance, many industry insiders argue that the complexity of mutual-fund trading creates an intricate maze of responsibility.
Many mutual funds are sold by third-party intermediaries, which include broker/dealers or financial advisers. In fact, according to statistics from the Investment Company Institute, 87 percent of mutual-fund shareholders invest through a third-party intermediary, either self- or broker-directed.
Ex-SEC Commissioner Laura Unger says that this structure creates confusion as to who owns the regulatory burden. "Is it originating at the mutual funds or brokerage firms, or is it a concerted effort by both?" she asks.
In addition, Gene Kim, a senior analyst at Financial Insights, says the proposal is riddled in ambiguity. "It's an unclear determination of where it has to be at 4 p.m.," he says, adding that the vagueness will likely be cleared up over the 45-day comment period.
Kevin McGovern, vice president of Rydex Funds' transfer agency, says that while the fund receives direct trades by 4 p.m. each day, the stop-over at the National Securities Clearing Corporation creates about a two-and-a-half-hour delay, which he estimates affects nearly 70 percent of the fund's volume of trades.
In addition to the potential delay from the NSCC, broker/dealers with slower processing technologies might need to cutoff trades even earlier in order to get transactions out the door, he adds.
The earlier cutoff at broker/dealers would reduce the amount of time investors have to trade.
Joanna Haigney, vice president of compliance at Rydex, notes that back-office processing at broker/dealers may soon be a competitive factor when investors choose mutual funds. "It puts a lot of pressure on back-of-house processing, such as the speed with which you can gather data, conduct processes, and feel that it is accurate," she says.
Brokerages that allow shareholders to trade later will have distinct competitive advantages over those with less timely back-office processes, she continues.
In addition, notes one industry source, a 4 p.m. deadline will create difficulties for intermediaries conducting interfund-family exchanges. The intermediary would have difficulty valuing a buy before the NAV is assigned, but would not have the option of transacting that buy once it has been valued, even if the shareholder made the order before the day's cutoff, he says.
Another issue with a hard 4 p.m. cutoff is the reality of exceptions processing, cautions Kim. "Often, there can be errors in processing or at the point of sale," he says, citing the possibility of a technology failure or miscommunication.
These errors, he goes on, can go undetected for hours or days, and adjustments must then be made at every point in the workflow. "There are all sorts of issues around 'as of' pricing, but it has to be allowed for and done because there can be breaks in systems," says Kim.
Rydex's Haigney agrees, and says, "If it comes down to having (the trade) at the mutual fund by 4 p.m., the mutual fund will have to have a TA system that can't be over-ridden. Exceptions will have to be documented clearly, with detail to the nth degree as to why they need to go through."