Question

ETHICS IN lNVESTING

When Mutual Funds Behaved Badly For nearly 95 million Americans who own them, mutual funds are a convenient and relatively safe place to invest money. So it came as a big shock to investors in September 2003 when New York Attorney General Eliot Spitzer shook the mutual fund industry with allegations of illegal after-hours trading, special deals for large institutional investors, market timing in flagrant violation of funds' written policies, and other abuses. Nearly 20 companies, including several large brokerages, were dragged into scandals. Some of the abuses stemmed from market timing, a practice where short-term traders seek to exploit differences between hours of operations of various global markets. For example, when the U.S. market rallies on strong economic news, short-term traders buy shares of U.S.-based international funds with large Asian holdings just before the close of the market at 4:00 P.M. EST. Prices of these funds, often calculated between 4:00 and 6:00 P.M., reflect closing prices of the U.S. securities but previous-day prices of Asian stocks, which typically don't close until 2:00 A.M. When the next-day Tokyo and other Asian markets rallied following Wall Street's lead, the market-timers sold shares of Asian holdings at the higher price, pocketing the profits. Most funds prohibit this kind of activity, yet exceptions were made for large institutional investors who traded millions of dollars' worth of fund shares. According to the regulators, this practice resembles betting on a winning horse after the horse race is over. Although late trading is illegal, many mutual funds did not enforce that rule for some of their privileged clients. The abuses did not stop there. The National Association of Securities Dealers and the SEC also cracked down on mutual fund sales practices that overcharged investors on sales charges, or loads. Also, several funds closed to new investors charged their existing shareholders millions of dollars in marketing and sales fees. Without at all excusing this unethical behavior, unlike the accounting and management fraud at companies like Enron and WorldCom, which caused their investors substantial losses, the mutual fund improprieties have not caused significant financial damage to their shareholders. Some estimates put the cost at about 0.1% of over $7 trillion invested in mutual funds. Most of that will be recovered since—as a result of settlements reached with the regulators—many mutual funds pledged to cut fees and lower fund expenses to benefit investors in the long run.

Please answer the question

CRITICAL THINKING QUESTION The SEC has proposed several regulations intended to curb mutual trading abuses. They include strict enforcement of trading hours and the imposition of 2% redemption fees if a fund is sold in less than 90 days. Do you think this will eliminate trading abuses?

Answer 1

Yes I agree that This is a unethical practice which all assets management company getting benefits of that . Thi sis also fact that There is ahuge impact of global market to each other market and due to differences in timing you can play wisely and make profite due to arbitrage situtaion.

Market timing in this context indicates a trader who invests in a mutual fund for sometimes as little as a day to profit from inefficient pricing. Late trading, an illegal activity is a similar strategy with one exception. Trades are placed after the market close yet the trader gets to buy in at that day's net asset value (NAV) per share. Generally, orders placed after the close of trade are supposed to be valued at the next day's NAV. one study that estimates that market timers cost mutual funds and their investors $4 billion a year.

Industry experts say that market timing of mutual fund shares is hardly a new phenomenon. And the SEC's failure to lead the way in uncovering recent scandals has led to widespread criticism of the commission. The SEC does perform detailed inspections of mutual fund firms every three years or so, about 90% of which result in the issuance of "deficiency letters," which outline ethical violations ranging from minor to extremely serious. But fund management doesn't have to disclose the contents of the deficiency letters either to fund shareholders or to its own board of directors. "Ninety-five percent of what managers are doing wrong never is made public," says Edward Siedle, a former attorney for the SEC who now investigates abuses at money-management firms for pension funds. If they were, he adds, they would be guaranteed to scare off a lot of investors.

Late-trading is illegal under federal securities laws as well as certain state statutes. It occurs when a mutual fund or intermediary permits an investor to purchase fund shares “late,” after the day’s NAV has been calculated, as though the purchase order had been placed before the NAV was calculated. For example, late-trading permits the investor to learn information after 4 p.m.—about public, potentially market-moving information (for example, key earnings releases, industry trend announcements and interest rate changes)—that more than likely will cause the next day’s NAV to increase. In essence the late-trader is permitted to capitalize on new information by turning back the clock and placing a trade as though it had been placed before learning the new information. Once the market-moving news is reflected in the fund’s share price and correspondingly increases the fund’s NAV, the investor can sell the fund shares at a profit.

I also agree that imposing 2% Exit load withinh 90 days can help to stop such practice up to some extend. They include strict enforcement of trading hours and the imposition of 2% redemption fees if a fund is sold in less than 90 days. This move of SEC can protect the interest of investors as because considering other market AMC may take call of redemption of funds however imposing such fee may reduce their marginal profit and they will endup with no additional profit situation.