Late-Day Trading Definition

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Late-Day Trading Definition

What Is Late-Day Trading?

Late-day trading is the unlawful practice of recording deals performed after hours as having happened before a mutual fund’s daily net asset value is calculated (NAV).It is often connected with hedge funds making orders to purchase or redeem mutual fund shares after the current period’s (generally daily) NAV has been formally computed, but getting a price that is usually more beneficial, based on the previous period’s NAV that has already been recorded.

Late-day trading may dilute the value of a mutual fund’s shares, affecting long-term investors, and should not be confused with after-hours trading, which is totally legal and appropriate.

Key Takeaways

  • Late-day trading is the unlawful practice of recording deals performed after hours as having happened before a mutual fund’s daily net asset value is calculated (NAV).
  • Late-day trading is often connected with hedge funds placing orders after the current period’s (generally daily) NAV has been formally computed, but getting the price based on the previously recorded preceding period’s NAV.
  • Late-day trading should not be confused with after-hours trading, which is entirely legal and accepted.

Understanding Late-Day Trading

Late-day trading refers to placing orders to purchase or redeem mutual fund shares after the most recent NAV has been determined. These transactions allow the investor to lock in the previous day’s NAV to their benefit, such as when a big component of a mutual fund reports profits after-hours that have a substantial influence on the fund’s value the following day.

Illegal late-day trading schemes often include hedge funds establishing special partnerships with mutual funds in order to purchase and sell those mutual fund’s shares after hours while having the deal documented as having occurred prior to the time when the mutual fund’s NAV is computed (normally 4:00 p.m. Eastern Time).This method allows hedge funds to possibly benefit from events that occur after the market closes, which is not accessible to ordinary investors. In return for mutual funds’ participation, these hedge funds may split a percentage of the unlawful earnings.

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Late-day trading contravenes federal securities regulations governing the price at which mutual fund shares must be purchased or redeemed. The Securities and Exchange Commission (SEC) has found that this sort of behavior defrauds innocent mutual fund investors by providing late-day traders an edge that other investors do not have.

Late-Day Trading Regulations

Several federal securities rules, including Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5, make late-day trading unlawful.

Broker-dealers and financial advisers were obliged to verify when deals were made under the initial late-day trading restrictions. Provided mutual funds received orders after computing the day’s NAV, they might still execute transactions if they were certified as having been made earlier. The objective was to allow consumers to conduct batch transactions, but mutual funds had no means of knowing whether any illegal trades were being done.

In the past, these restrictions generated several problems. Geek Securities, for example, is a broker-dealer and investment adviser that was charged with accepting trading orders from clients after 4:00 p.m. Eastern Time and executing those transactions as if they had been received before to that time. Phone calls were unreported, and the adviser concealed late-trading activity by using a time-stamp machine.

In 2003 and 2004, the SEC made substantial adjustments to late-day trading restrictions. The new regulations required mutual funds to accept buy and redemption orders prior to calculating NAV and enhanced market timing disclosures in mutual fund prospectuses. These regulations moved enforcement responsibilities to mutual funds.

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Late-Day Trading Fines

The SEC penalized the former United Kingdom hedge fund Pentagon Capital Management $98.6 million for late-day trading violations that occurred between February 2001 and September 2003. The hedge fund used its broker-dealer, Trautman Wasserman & Co., to execute late-day transactions in order to benefit unlawfully from information available after mutual fund prices were set at the end of each day.

The hedge fund claimed that the transactions were neither fraudulent or deceptive under federal securities laws and that it could not be held accountable as an investment adviser since it did not contact directly with mutual funds. However, the judges decided that deceptive purpose is inherent in late trading and that the hedge fund had last say regarding communication permission even if the broker-dealer was ultimately responsible for making the deals.

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