Late Trading

An investor submits a mutual fund purchase order at 5:15 pm ET, after the fund's 4:00 pm pricing time. Executing that order at the 4:00 pm NAV computed earlier the same day would be:

1. A.Permissible because the order was placed on the same calendar dayWrong. The pricing cutoff, not the calendar day, controls which NAV applies.
2. B.Illegal late trading; the order must receive the next business day's NAVCorrect. Pricing an after-cutoff order at the earlier NAV violates forward pricing.
3. C.Required, because customers always get the most recent computed priceWrong. Customers get the NEXT computed price, never the most recent one.
4. D.Permissible if the customer pays an extra service feeWrong. No fee can legitimize late trading.

Why: An order received after the pricing time must be executed at the next computed NAV, the following business day's price. Filling it at the already-struck price is late trading, a fraudulent practice. Citation: SEC Rule 22c-1; SEC late-trading enforcement actions. Takeaway: after the cutoff, the order gets tomorrow's NAV.

Verrall Capital, a hedge fund, has an arrangement with a broker-dealer permitting it to submit mutual fund orders as late as 6:00 p.m. Eastern and still receive that day 4:00 p.m. net asset value, after the evening news is known. A different investor trades in and out of an international fund frequently but always submits orders before the 4:00 p.m. cut-off. Which statement is correct?

1. A.Both practices violate Rule 22c-1, since both are attempts to profit at the expense of long-term shareholdersOrders placed before the cut-off are priced correctly under Rule 22c-1. Motive does not make a properly priced order a pricing violation.
2. B.Both practices are permissible provided the fund discloses them in its prospectusNo disclosure can authorise pricing an order at a net asset value computed before the order was received.
3. C.Late trading is permitted for institutional investors, whose orders are negotiated rather than retailRule 22c-1 draws no line between institutional and retail orders. Both must receive the next computed price.
4. D.The 6:00 p.m. arrangement is late trading and violates the forward pricing rule; the pre-cut-off frequent trading is market timing, which the fund may restrict through its disclosed policiesCorrect. Late trading breaks Rule 22c-1 and defrauds other shareholders. Market timing is addressed by fund policy, exchange limits, redemption fees and Rule 22c-2 agreements.

Why: The 6:00 p.m. arrangement is late trading. Rule 22c-1 requires that an order receive the next net asset value computed after the order is received, so pricing a 6:00 p.m. order at the 4:00 p.m. figure hands the trader a free look at post-close information at the expense of every other shareholder. It is a violation and, given the concealment involved, a fraud. Frequent trading placed before the cut-off is market timing: not itself unlawful, but disruptive, and funds may and do restrict it through disclosed frequent trading policies, exchange limits, short-term redemption fees and Rule 22c-2 information agreements.