SEC Proposes New Rule on Large Trades

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Who’s doing what and will it help us or hurt?

Essentially, that’s what the Securities and Exchange Commission wants to find out with a proposed rule requiring more reporting of big trades. If passed after a 60-day public comment period, the rule would define large traders as individuals or firms conducting trades of securities listed on ordinary exchanges that equal or exceed 2 million shares or $20 million in a single day, or 20 million shares or $200 million a month.

The rule would therefore cover mutual fund companies as well as hedge funds, pension funds, investment banks and other big traders. The SEC wants a better look at how big trades affect the market.

In the past year or so, some regulators, lawmakers and other observers have worried that huge, computerized trades conducted at ultra-high speeds give professionals an unfair advantage over ordinary investors by driving prices up and down in ways that might defy normal supply and demand.

There also has been some concern about the effect of “dark pools,” secretive trading systems for professionals that could be influencing prices on the ordinary exchanges.

If passed, the rules might also provide new insight into mutual funds. Funds typically report their holdings each quarter, but only list the securities they own on the reporting date. Critics have charged that some funds engage in “window dressing,” buying the latest hot stocks, and dumping bad ones, just before the reporting deadline, to make managers look better.

With better access to big trades, the SEC might get a clearer look at how widespread this practice is.

While fund managers describe their general principals in prospectuses and other marketing materials, the details of their stock-picking systems are kept secret else competitors follow suit.

The SEC proposal edges toward a sensitive question: Should all fund trades be disclosed – not just to the SEC but to everyone? Fund companies would surely object, as complete disclosure would reveal proprietary trading strategies. And, as a practical matter, disclosing all trades day by day could encourage practices like “front running.” That’s when other traders copy a big player’s moves, knowing a big buy order will drive a stock’s price up and vice versa.

That problem could be avoided if trades were disclosed with a delay of weeks or months. Even with disclosure delayed, savvy investors and research firms like Morningstar Inc. (Stock Quote: MORN) would be able to tell which fund managers were really skilled at picking hot stocks and which were not. Currently, a fund can only be judged by comparing its performance to its peers and benchmarks, making it hard to tell whether an apparently successful fund manager is good or just lucky.

Investors who would like total, public disclosure of fund trades shouldn’t hold their breath, as there would be enormous opposition from the fund industry.

But there is a simple solution for investors who want to know what their funds own all the time, not just on a reporting date. They can invest in index-style mutual funds and exchange-traded funds. Because these mirror the holdings of market gauges like the Standard & Poor’s 500, whose members are known, you always know what your index fund contains. You don’t have to worry your fund manager is trying to hoodwink you with window dressing.

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