Market Timing

Wrenbury Global Fund believes a small number of investors are trading in and out of the fund rapidly, but their orders arrive inside the aggregate omnibus account of a large retirement plan intermediary, so the fund cannot see who they are. Under SEC Rule 22c-2, the fund is entitled to:

1. A.Impose a redemption fee of up to 5% on the intermediary entire omnibus positionThe rule permits a redemption fee of up to 2%, charged to the redeeming shareholder and paid to the fund, not a penalty on the intermediary whole position.
2. B.An order requiring the intermediary to convert every omnibus account into individual networked accountsRule 22c-2 does not outlaw omnibus accounts. It gives the fund the information rights it needs to supervise them.
3. C.A written agreement under which the intermediary supplies shareholder tax identification numbers and transaction history on request and enforces the fund restrictions on identified shareholdersCorrect. Rule 22c-2 gives the fund both a look-through right into omnibus activity and the power to have its trading restrictions carried out at the intermediary.
4. D.Report the intermediary to the SEC, which then obtains the shareholder identitiesThe rule is self-executing through contract. The fund obtains the information directly under the required agreement.

Why: Rule 22c-2 requires a fund to have a written agreement with each financial intermediary under which the intermediary will, on request, provide the taxpayer identification numbers and the share purchase, redemption and exchange history of the underlying shareholders, and will execute the fund instructions to restrict or prohibit further purchases or exchanges by a shareholder the fund identifies as violating its frequent trading policy.

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.