Q & A: Mutual Fund Trading Policies and Practices
The Ontario Securities Commission (OSC) investigation into mutual fund trading practices has generated questions and concerns regarding our policies and practices. In an effort to help address these questions, the following information has been prepared to provide some background and outline TD Asset Management's (TDAM's) position and policies.
Current Status of the Regulator's Investigation
Q: What is the status of the OSC investigation into late trading and market timing?
A: The Ontario Securities Commission investigation was conducted in three phases. In the first phase, which began in November 2003, all Canadian mutual fund managers were asked to provide information on any late trading or market timing activities of which they were aware, and for a description of their policies and procedures to prevent late trading and market timing. In the second phase, the OSC selected 36 fund companies and requested more detailed information in an effort to assess their procedures and practices as they related to late trading and market timing.
In the third phase, the OSC conducted an analysis of trading data and held site visits for 20 fund managers. On October 1, 2004 the OSC issued a press release indicating that they were in discussions with certain money managers with a view to resolving allegations of market timing by some investors in funds they managed. On December 16, 2004 the OSC approved settlement agreements concerning market timing activities. The OSC also announced that there has been no evidence of late trading activity detected in Canada and all indications of market timing had ceased for some time. The OSC also announced on December 16, 2004, that their probe into trading activities in mutual funds was complete.
LATE TRADING
Q: What is late trading?
A: Late trading is illegal and occurs when mutual fund trade orders are received after a fund's cut-off time (typically when stock markets close at 4:00 PM Eastern Time [ET]), but are filled at that day's unit price rather than the next business day's unit price. Late trading is a violation of National Instrument 81-102, a nationally adopted instrument that regulates mutual funds.
Q: Why is late trading a concern?
A: It is a concern because of the opportunity this creates for investors to trade and financially benefit from knowledge not available to the fund's other unitholders who placed orders before 4:00 PM ET.
Q: Does TDAM have a policy on late trading?
A: Yes. Our policy is that mutual fund trade orders received after 4:00 PM ET receive the next business day's unit price. All of TD Mutual Funds' record-keeping systems are designed to move orders received after 4:00 PM ET to the next business day.
MARKET TIMING
Q: What is market timing?
A: Market timing strategies generally involve short-term trading of mutual funds to take advantage of short-term discrepancies between the expected current price of a security and the stale value of that security used in valuing the fund's portfolio. International funds are vulnerable to this type of trading, as traders can exploit differences between time zones.
Periodically, events that could reasonably be expected to impact the value of a security or an entire market occur after a security has been priced in a foreign market. Examples of events might be a major political announcement or resignation of people critical to the operation of a company. In these circumstances, the closing mutual fund price(s) may not fully reflect the expected current value(s) of the affected security(ies); these prices are sometimes referred to as 'stale' prices.
Q: Why is market timing of concern?
A: The movement of cash in-and-out of a fund is not optimal for the long-term operation of a fund. In some cases, a fund's portfolio manager may buy securities to keep the fund fully invested and then sell these same securities to cover the subsequent redemption. This can also create the need to keep additional cash to cover redemptions and these activities result in increased custody, trading, and transaction costs.
Q: How does TDAM discourage market timing?
A: While market timing is not illegal, our funds are designed for long-term mutual fund investors. TDAM started to charge an early redemption fee (ERF) for most TD Mutual Funds many years ago. This 2% fee is applied to investors that buy and sell units of the same fund within 30 or 90 days, thus discouraging for market timing. The amount charged by this process is paid to the fund to cover any costs or possible negative impact to the fund or its unitholders. In addition, we also retain the right to reject purchase orders from a unitholder who is conducting any activity considered detrimental to the funds or its unitholders.
At TD Mutual Funds we are committed to protecting the best interests of our unitholders. We strive to apply the highest standard of care and diligence, and we review our current policies and practices regularly to ensure they continue to protect you and the funds.
Updated December 2004
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