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RBC takes steps to stamp out abusive trading in its funds

Royal Bank of Canada has adopted a system to update prices of mutual funds that have international stock holdings, part of a revamped effort to stamp out abusive trading in its funds.

RBC Asset Management Inc., a wholly owned subsidiary of RBC and the largest fund company in Canada, recently began using a so-called fair-value pricing system for all of its mutual funds that own shares in companies outside North America. Fair-value pricing involves using estimates to set the value of securities in a mutual fund.

It is considered an effective tool to curb market timers who take advantage of time-zone differences in international funds, where events after overseas markets close often make prices out of date.

"Our responsibility [is] to protect the fund and our unitholders against excessive trading practices, including market timing, and we're taking steps to ensure that we do that," Jonathan Hartman, RBC's vice-president of business development, said yesterday.

Fair-value pricing has received renewed attention following an investigation into widespread market timing and other improper trading practices in the U.S. fund industry.

Since New York State Attorney-General Eliot Spitzer launched his crackdown on market timing last September, FT Interactive Data, a Bedford, Mass.-based company that provides updated closing prices on stocks to fund companies, has seen its client base more than triple to 70, said FT spokeswoman Jeanne Murphy.

RBC is the company's first client in Canada and only the third to adopt fair-value pricing in this country.

Boston-based fund giant Fidelity Investments has used fair-value pricing for its global operations, including Canada, since the early 1990s. Clarington Funds Inc. of Toronto began fair valuing foreign securities in its funds in May.

Fidelity Investments Canada Ltd. has been urging other fund companies to follow its lead. "It's great to see its use become more widespread," said spokeswoman Kim Flood, in response to RBC's move. "Fair-value pricing is . . . a key piece of any process to prevent abusive trading."

Frank Lippa, chief financial officer at RBC, said the firm began taking a hard look at using fair-value pricing in March. "More companies are adopting it, and we thought we'd take a leading position and adopt it ourselves," he said.

RBC has introduced the system following revelations that market timing might have been prevalent in Canada as well as in the United States, where the confidence of investors has been badly shaken by revelations of widespread wrongdoing.

A Report on Business investigation last month found that a select group of hedge fund managers and other market professionals siphoned off hundreds of millions of dollars of value from Canadian mutual funds over a four-year period.

Rapid in-and-out trading in mutual funds totalled more than $220-billion between 2000 and 2003, a pattern highly suggestive of market timing, the investigation found.

Report on Business found 248 funds where active trading took place, 13 per cent of all the funds examined. Nearly half were Asian or European funds.

Funds that invest in overseas markets are particularly vulnerable to market timers. By the time prices are set in these international funds, overseas markets have been closed for as many as 14 hours, and events elsewhere around the globe can make their closing prices obsolete.

The patterns were detected by calculating churn rates -- levels of sales, redemptions and transfers into and out of a fund as a percentage of average assets.

The funds singled out had three characteristics: annual churn rates exceeding 100 per cent, churn that resulted mainly from money being transferred to and from funds within the same company, and monthly transfers in and out that were roughly similar. Two of RBC's international funds were on the list.

RBC is one of many fund companies that are bolstering their efforts to clamp down on market timing in their funds, even though the activity has all but stopped in the wake of the U.S. probe.

In Canada, there are no rules that require fund companies to fair value stock prices. In the United States, by contrast, the Securities and Exchange Commission has done several things to stress the importance of fair-value pricing, said Barry Barbash, a Washington lawyer and former SEC official.

The SEC recently introduced a rule requiring fund companies to disclose when they use fair-value pricing. As well, SEC staff are contemplating taking enforcement action against funds that do not use it.

© 2007 The Globe and Mail. All rights reserved.

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