CASE: CANARY CAPITAL PARTNERS LLC: MUTUAL FUND ABUSES
Edward Stern at Canary Capital Partners LLC, a hedge fund, oversaw a partnership with as many as 30 mutual fund companies-including Bank of America, Security Trust Company, Bank One, Janus Capital, and Strong Capital Management-to engage in late trading and market timing.
Mutual funds are priced once daily at 4:00 p.m. EST after markets dose. This price, known as the net asset value (NAV), will be the fund's price the following day. Allowing some investors to transact after hours, but before the new NAV is determined, is known as late trading. Investors can purchase (or sell) at the stale price, knowing that the following day the NAV will be higher (or lower) and thereby guarantee a profit. Market timing occurs when investors are allowed to transact during the day at the prior day's NAV, thus taking advantage of information that will change the new NAV after the close.
Some mutual funds do not have enough time during the day to fulfill all their trade requests, so they fulfill these trade requests after hours.
The mutual funds permitted Canary's trading practices as long as Canary kept other assets with the investment management portion of the mutual fund firms. Canary kept millions of dollars of assets invested with the funds and also generated substantial brokerage commissions through trading.
DISCUSSION QUESTIONS
1. Who is hurt by late trading and market timing?
2. What were the mutual fund's motives for allowing such trading?
3. Why do you think Canary Partners pursued market timing and late trading as an investment strategy? How is this similar or dissimilar to other investment strategies that hedge funds typically pursue?
4. Are there ever any ethical reasons to allow for late trading or market timing?
Canary Capital Partners LLC: Mutual Fund Abuses, discuss the negative consequences of late trading and market timing. Why would Canary Partners pursue these investment practices? What advantages would it give them? What ethical reasons might allow for these investment strategies to be used?