Market timing refuses to go quietly.
A litigious Chicago-area hedge fund is taking the
Securities and Exchange Commission
to court in a bid to block a new regulation designed to stop market-timing trading abuses in the mutual fund industry.
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The lawsuit filed earlier this month by
contends significant portions of the new regulation are "invalid and unenforceable." The Northbrook, Ill.-based hedge fund is asking a federal appeals court in Chicago to strike down the regulation approved by the SEC on April 13.
The hedge fund, managed by Gary Hokin and Rob Rubin, has had a history of suing insurance companies that tried to stop their hedge fund from market timing variable annuities, which are life insurance products that resemble mutual funds. In recent years, Emerald Investments and its general partner,
, have sued
Equitable Life Assurance
seeking to enforce the hedge fund's right to market time those insurer's variable annuity products.
This latest lawsuit presents a broad assault on the nearly 10-month campaign by the SEC and New York Attorney General Eliot Spitzer to eliminate abusive trading activities in the mutual fund industry.
The new SEC regulation, enacted in the aftermath of the scandal that has roiled the $7.4 trillion mutual fund industry, requires all mutual funds to spell out the risks associated with market timing and each fund's policy on combating it. The regulation also requires mutual funds to make greater use of a mathematical formula called "fair value pricing" to determining the value of each fund's shares.
Fair value pricing is intended to eliminate the potential for so-called stale pricing, a problem that sometimes crops up with mutual funds since they are usually priced once a day after the close of trading. In fair value pricing, a fund company can estimate the value of individual stocks in a fund, taking into account the impact of a subsequent market-moving event.
Market timers try to take advantage of stale prices by engaging in a strategy that involves frequent trading of mutual fund shares. The strategy usually involves an arbitrage using the time difference between the close of U.S. and foreign markets.
While market timing is technically legal, the frequent trades can dilute the value of a fund's assets and incur added administrative costs.
The lawsuit specially challenges the fair value pricing portion of the regulation.
The hedge fund contends the SEC violated federal rulemaking procedures because it adopted the fair value pricing provision "without considering any data or studies" and "without considering alternatives." The lawsuit also says the new regulation conflicts with the Investment Company Act, the law the governs the mutual fund business, which requires fund companies to "use actual market prices unless they are not readily available."
A spokesman for the SEC declined to comment on the lawsuit, which was filed on June 10. Attorneys for Emerald Investments did not return telephone calls.