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Tuesday, Mar 23, 2004

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SEBI must look beyond the clock

THE NEW RULE of the Securities and Exchange Board of India requiring mutual funds to stick to uniform cut-off timings for processing of transactions is welcome, as it will make it more difficult for fund houses, or their distributors, to offer back-dated prices to select, big investors. But the rule, in itself, may not be enough to protect investors from the damage inflicted by short-term trading in a fund's units. SEBI should consider following this up with the imposition of a sizeable exit load on short-term investments in mutual funds and a crackdown on selective disclosure of portfolios by fund houses.

A single cut-off time of 3p.m. across funds for processing of transactions will certainly mean less confusion for investors about the price at which their purchase or saleis made. Some funds now have as many as three cut-off times for different kinds of transactions. A uniform cut-off timing will also make it easier for the regulator to catch a fund house or an intermediary bending the rules for a favoured investor. The requirement that all funds follow forward pricing for all their products (except liquid funds) is yet another positive. This may reduce the distortions that arise when informed investors enter a fund based on a sale price (the net asset value) and make a killing on events that occur after the fund's official cut-off time. SEBI's requirement that funds time-stamp all transactions as soon as they are received may help it monitor fund transactions, to make sure that the cut-off time is being adhered to.

But recent events in the US have proved that even stringent stipulations can be got around, if players have enough to gain. "Late trading", which SEBI is now trying to prevent, appears to have been quite common in the US, despite regulations that mandate forward-pricing and time-stamping. In fact, while recently tightening its regulatory framework to prevent such practices, the US Securities Exchange Commission noted that "late-trades" were disguised as bona fide trades with the complicity of fund intermediaries; especially as the technology for time-stamping is not fool-proof. To deter short-term trades, the SEC mooted (and the fund industry endorsed) a 2 per cent redemption charge for all investments parked in any fund for less than five days.

SEBI also must look into the host of other industry practices that actually encourage large investors to park their temporary surpluses with mutual funds. Many debt funds penalise, with a 0.5 per cent exit load, small investors pulling out of a fund within six months of the initial investment. But they waive this exit load for transactions that run into several lakh rupees, though these have greater potential to derail fund management. Funds are also willing to woo institutional investors with lower management and transaction fees via special "institutional" plans, while retail investors are required to fork out fees, usually at the SEBI-specified upper limit. Such practices are, in fact, more prevalent than "late-trading" and have a more direct and visible impact on the returns of long-term fund investors.

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