HSBC fined for market timing, under-reporting

(August 31, 2005) After more than an hour of deliberations, an IDA hearing panel today accepted a settlement agreement negotiated between staff of the IDA and HSBC Securities over its role in allowing offshore clients to market time trades in mutual funds from six fund companies.

From January to July 2002, HSBC earned more than $500,000 in management fees and trailer fees through a special arrangement with an offshore client that allowed the client to trade mutual funds, without a minimum hold period, for a fee which was significantly less than the maximum switch fee that could have been charged. During that time, the client executed roughly 800 trades, ranging between $99,000 and $14,500,000 each. On average, the mutual funds were held in the client’s accounts for less than five days.

In addition to mutual funds from other companies, HSBC also allowed timed trades to occur in two of its own funds — the HSBC Global Equity Fund and the HSBC European Fund. In both cases, the fund prospectus said investors in the fund should have a long-term investment horizon. In total, the client’s activities affected 14 different funds from six mutual fund companies.

Frequent purchases, redemptions and switches raise transaction costs and generate taxable capital gains for mutual fund unitholders, disrupt portfolio management strategies and can force fund managers to increase borrowing or hold larger cash reserves than necessary or desirable. Mutual fund companies issued written warnings to HSBC, saying that market timing was not welcome or permitted because of its potential to harm long term unit holders. Despite this, the company allowed the client to continue trading in and out of the funds.

The IDA fined HSBC $506,596 plus investigation costs of $50,000, and ordered the company to disgorge market timing revenues of $506,596. A similar formula was used last year when the brokerage industry association penalized three Canadian bank brokerage firms more than $41 million.

In addition, HSBC Securities was fined $100,000 for under-reporting information about market timing trading done by the firm on behalf of clients in a January 2004 survey of association members. Both the IDA and HSBC say the company’s failure to fully disclose its activities was completely unintentional.

The infraction was discovered when the IDA requested additional information about market timing activity from its members in February 2005. HSBC says the misrepresentation was a result of poor communication between relevant personnel at the firm, and told the IDA about the mistake in March.

“The panel had vibrant questions about the settlement agreement,” says Jeff Kehoe, IDA director of enforcement litigation. “The issue of under-reporting is without precedent at the IDA.”

In addition to the penalties, HSBC will be required to provide a report within the next six months to update the IDA’s sales compliance department about the company’s efforts “to identify and address emerging issues in the securities industry.”

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@advisor.rogers.com