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Study Suggests Illegal Trading at Year's End


Some fund managers are engaging in possibly illegal trading on the last day of the year in an effort to manipulate the year-end value of their funds, according to a recent study released by the Wharton School of Business of the University of Pennsylvania.

Fund managers artificially inflate the value of funds by purchasing stock funds they already hold, driving up the price of the stocks and also the value of the funds, according to the study.

The study examined the price shifts of 2,423 mutual funds on the last day of the year and the first day of the year between 1985 and 1995. The average equity fund ended the last trading day 53 basis points higher than the S&P 500 and closed the first trading day 37 basis points lower than the S&P 500, the study found.

In a nine-year period, eighty percent of funds beat the S&P 500 on the last day of the year and only 30 percent beat it on the first day of the year, according to the study. The study also examined fluctuations on the last and first day of the quarter for each year. Fluctuations also occurred at quarter-ends, but on a much smaller scale, according to the study.

The SEC declined comment on the study.

But, it will probably give the study a close look, said Pamela Wilson, a mutual fund lawyer with Hale and Dorr LLP of Boston.

"The SEC will figure out if there is something going on that shouldn't be," she said. "I don't know who the suspects would be but they will get a hold of the study's author and review all of the data."

The practice is illegal under the Securities Exchange Act of 1934 because it manipulates stock and fund share prices, she said.

Fund managers with a fund competing at the end of the year for a top ten spot are suspected of making these types of trades, according to Stephen Musto, the Wharton professor who helped conduct the study. Because of the emphasis placed on the funds' year-end value in mutual fund ratings and databases, fund managers are tempted to engage in these kinds of trades, he said.

The study, however, does not examine other possible causes for the fluctuations, according to Geoff Bobroff, president of Bobroff Consulting of East Greenwich, R.I., a mutual fund consulting firm. Fund managers will often purchase additional shares of a stock to "round out" the fund's holdings in order to clean it up for year-end presentation and prospectuses, he said. There are also other market influences that drive up stock prices on the last day of the year, he said.

"Let's just say I am underwhelmed by the academic research of this study," said Bobroff. "Could there be some fund managers out there that engage in this kind of trading? Probably. But it's a small subset and hopefully we don't tar the industry with the shenanigans of a few people."

Trading to inflate the value of the fund, although illegal, is difficult to police, Musto said.

"A fund manager can just say they purchased the stock because they liked it," he said. "I haven't heard of anyone or any fund company getting caught for this."

But the SEC will look for circumstantial evidence by examining the study's data and any patterns it finds that might indicate illegal trading activity, Wilson said.

"If there is something illegal going on, they will unearth it," she said.

The study will also force fund companies to start watching their portfolio managers more closely, Wilson said.

"I imagine every lawyer like me will be advising fund boards on what's going on," she said. "Now they have a duty to ask about this."