Fund companies begin disclosing trading policies

(November 7, 2003) Canada’s mutual fund companies are responding to a call from the country’s largest securities regulator for information on their trading policies. The move comes in the wake of a fund industry scandal south of the border, where a number of major companies have been accused of late trading and market timing abuses.

Earlier this week, the Ontario Securities Commission (OSC) sent a letter to the 105 fund companies based in the province, asking if they have policies and procedures in place to detect and prevent trading abuses. OSC chair David Brown says that while there are no indications that the problems in the U.S. are being replicated in Canada, the regulator wants to ensure that fund investors can have confidence in the industry.

Fidelity Investments Canada was first out of the gate, posting a statement on trading policies from president David Denison on its Web site today. “With so much attention on mutual fund trading policies, we wanted to let you know what Fidelity Canada does to combat disruptive trading and protect the interests of our long-term investors,” Denison said.

Denison says Fidelity Canada does not permit after-hours trading. “We simply do not allow any orders received after the 4 p.m. market close to obtain the 4 p.m. price. It is a firm and non-negotiable policy, and always has been.”

Fidelity also works to prevent time-zone arbitrage, Denison says, when traders attempt to profit on differences in securities prices between various time zones.

To combat this, Fidelity uses fair value pricing, to help ensure that a fund’s net asset value reflects market conditions at 4 p.m. eastern time. “This effectively closes the window of opportunity that time-zone arbitrageurs might otherwise aim to exploit,” says Denison.

Analysts note that fair value pricing is not always effective. “Anytime the industry must engage in guessing unit prices, some investors are inevitably hurt,” said independent fund industry analyst Dan Hallett in a recent report on the fund trading scandals.

Hallett says a more straightforward approach is to charge a flat percentage fee for short-term trades. Most fund companies have such a fee written into their prospectuses. But in practice, Hallett says, most companies don’t exercise their right to charge the fee until the trading becomes too frequent and involves large dollar amounts.

Denison says Fidelity applies trading fees to any short-term trading they feel is disruptive to the funds. “We apply mandatory short-term trading fees to Fidelity Far East Fund and Fidelity Japan Fund, which are most vulnerable to time-zone arbitrage,” he says. “In addition, we apply discretionary fees to any other fund when we think it is appropriate.”

The trading fee is usually set at 2% of a fund’s value. Hallett thinks that might be too low. “One possibility is to simply raise it across the board, to something like 5%, at least on equity, specialty and balanced funds,” he suggests. “Another option is to scale the fee based on the amount of dollars or percentage of fund assets involved, since trading by small investors will do no harm to remaining unitholders.”

IFIC, the industry association for Canada’s fund industry, today came out in support of the OSC’s survey of trading practices.

“We look forward to working co-operatively with the OSC through this survey process, bearing in mind that there are significant differences in how the fund industry operates between Canada and the U.S.,” said IFIC president Tom Hockin. “Mutual funds help millions of people achieve financial security and we will honour their trust.”

Filed by Doug Watt, Advisor.ca, dwatt@advisor.ca