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Market Timing and Late Trading


Market timing includes (a) frequent buying and selling of shares of the same mutual

fund or (b) buying or selling mutual fund shares in order to exploit inefficiencies in mutual fund pricing. Market timing, while not illegal per se, can harm other mutual fund shareholders because

it can dilute the value of their shares. Market timing can also disrupt the management of the mutual fund’s investment portfolio and cause the targeted mutual fund to incur costs borne by other shareholders to accommodate frequent buying and selling of shares by the market timer.


Rule 22c-1(a) under the Investment Company Act requires investment companies

issuing redeemable securities, their principal underwriters and dealers, and any person designated in the fund’s prospectus as authorized to consummate transactions in securities issued by the fund to sell and redeem fund shares at a price based on the current net asset value (“NAV”) next computed after receipt of an order to buy or redeem. Mutual funds generally determine the daily price of mutual fund shares as of 4:00 p.m. ET. In these circumstances, orders received before 4:00 p.m. must be executed at the price determined as of 4:00 p.m. that day. Orders received after

4:00 p.m. must be executed at the price determined as of 4:00 p.m. the next trading day.


“Late trading” refers to the practice of placing orders to buy or sell mutual fund

shares after the time as of which a mutual fund has calculated its NAV (usually as of the close of trading at 4:00 p.m. ET), but receiving the price based on the prior NAV already determined as of 4:00 p.m. Late trading enables the trader to profit from market events that occur after 4:00 p.m. but that are not reflected in that day’s price. In particular, the late trader obtains an advantage – at

the expense of the other shareholders of the mutual fund – when he learns of market moving information and is able to purchase (or sell) mutual fund shares at prices set before the market moving information was released. Late trading violates Rule 22c-1(a) under the Investment Company Act and harms other shareholders when late trading dilutes the value of their shares.

CIHI Improperly Provided, and World Markets Improperly Arranged For, Credit to Their Hedge Fund Customers


From 1998 to 2003, CIHI provided leverage to numerous hedge fund customers

engaged in the late trading and/or market timing of mutual funds. At its height, CIHI had over $2 billion in leveraged transactions on its books. CIHI provided this leverage through two financing

vehicles, loans and TRSs.


Under the TRSs, both CIHI and the hedge fund would contribute money to a

managed account, usually in ratios of 4:1 leverage, although in some instances this ratio was even higher. CIHI then placed the funds it contributed (i.e., 80% of the funds) (“the floating

notional”) as well as the funds the hedge fund customer contributed (i.e., 20% of the funds), in an account at a broker-dealer or trust company (“the managed account”). (The total amount of

funds that CIHI and the customer contributed was known as the “total notional.”) Although the managed accounts were in CIHI’s name, and CIHI retained the power to liquidate the shares at any

time, the hedge fund customer selected an investment manager to make all trading decisions.


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