Most Read Contributor in Hong Kong, September 2016
Written by Phillip Smith (Partner) and Kevin
Brocklehurst (Registered Foreign Lawyer
'Market timing' and 'late trading' have become
hot topics since September 2003 when New York State
Attorney-General Eliot Spitzer accused mutual funds of
short-changing small investors by giving hedge funds special
Mutual funds generally require investors to submit their orders
to buy or sell prior to a specified dealing deadline or cut off
Investors pay or receive the fund's 'net asset
value' which is determined once per day at the pricing or
valuation point i.e. the exact time at which reference is made to
the market price of a stock in the fund's portfolio.
Orders received after the dealing cut off time are supposed to
be executed at the next day's pricing point.
Late trading occurs when certain selected investors are favoured
by being allowed to submit orders to buy or sell after the dealing
cut off time. Late trading investors receive 'backward
pricing', that is, the price calculated at the pricing point
that has already passed.
Late trading has been compared to placing a bet on a horse race
after the horses have passed the finishing post!
Late trading investors benefit as they can make an investment
decision based on the availability of price sensitive information
affecting the underlying stocks.
Market timers take advantage of these 'stale' share
prices. Because some markets, especially in Asia, close hours
earlier than in the U.S., the prices of those shares often
don't reflect the latest news when the funds determine Net
Asset Value (NAV) at say 4.00 p.m. Eastern U.S. time on the
basis of closing prices at the end of the Asian trading day.
In market timing or front running, investors analyse the pricing
point and the dealing cut off time and take advantage of time zone
differences to, for example, buy or sell shares in a mutual fund
they believe is about to rise or fall in value because of news
affecting the underlying stocks and bonds held by that mutual fund
- news that has come out after overseas markets have closed.
While not illegal, most funds claim to have polices and
procedures aimed at preventing market timing trades, as such trades
are felt to increase transaction costs borne by the fund and leave
funds with unexpected pools of cash that cannot be invested because
it must be set aside to satisfy redemptions by market timers.
The Securities and Exchange Commission in the United States has
proposed a rule to prevent late trading by establishing a 'hard
cut off' dealing deadline after which no backward pricing will
Securities regulators in the United Kingdom, France, Germany,
Italy, Canada, Switzerland, Luxembourg and Ireland have initiated
probes into both late trading and market timing.
In Hong Kong, the Securities and Futures Commission (SFC) is
studying late trading and market timing.
As most funds marketed to Hong Kong investors are domiciled in
offshore jurisdictions such as Luxembourg and Ireland, any actions
taken by the regulators in those jurisdictions may be sufficient to
address any concerns the SFC may have in furthering its mandate to
protect Hong Kong investors.
The original email legal update is copyright Johnson
Stokes & Master at the date written first above. All rights
reserved. This publication provides information and comments on
legal issues and developments of interest to our clients and
friends. The foregoing is intended to provide a general guide to
the subject matter and is not intended to provide legal advice or a
substitute for specific advice concerning individual situations.
Readers should seek legal advice before taking any action with
respect to the matters discussed herein. Please also read the JSM
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