Fidelity, clearing firm explore idea of ‘time-stamping’ trades to halt abuses

By DIANA B. HENRIQUES New York Times

Friday, December 26, 2003

In the mutual fund world, they call it “the hard 4,” the unyielding 4 p.m. Eastern time deadline for customer orders. Fund industry leaders propose it as the best antidote for late trading, one of the crimes that have come to light in the current mutual fund scandal.

The question is whether regulators can end the abuses without having a cure that is as bad as the disease. The answer? Maybe — if all the players can agree on an idea now under discussion.

In pre-scandal days, fund companies trusted various order-taking intermediaries — banks, brokers, third-party retirement plan administrators — to shut their windows to new business at the legal deadline, then accepted those intermediaries’ orders well into the night. That trust, it turns out, was misplaced, and several big intermediaries and fund companies stand accused of conspiring with market-timing hedge funds to slip orders in long after the cutoff.

The “hard close” plan, high on Washington’s list of proposed reforms, would prevent those late trades. But that could hurt the millions of Americans who invest through 401(k) plans that rely on intermediaries to submit orders. To meet the new deadline, those middlemen would have to set even earlier deadlines for their customers to give them time to process the trades. For investors on the West Coast, that could mean submitting orders even before the business day starts.

However, a more acceptable treatment may be in the works, thanks to a quiet alliance between two formidable forces — Fidelity Investments, the world’s largest mutual fund company, and the National Securities Clearing Corp., the obscure giant that handles the bulk of Wall Street’s electronic “back office” order processing.

They are leading an effort to transform an existing fund-order processing service at the clearing corporation into the kind of time- stamped “lock box” that would give fund middlemen more time to process orders while assuring that no late orders could be taken. That would satisfy regulators and industry executives without penalizing investors. And their work recently received an encouraging nod from the Securities and Exchange Commission.

The SEC released its proposed “hard close” rule on Dec. 11, seeking public comment. The rule would require that orders be received by 4 p.m. Eastern time at the fund company or its transfer agent — or, in an unexpected alternative, at “a clearing agency registered with the commission.” And the only clearing agency now registered is National Securities Clearing, a subsidiary of the Depository Trust and Clearing Corp., an industry-owned behemoth that handles $917 trillion worth of financial transactions a year.

“There’s not going to be a silver bullet — this clearinghouse idea will take a lot of work by a lot of people,” said Robert L. Reynolds, vice chairman and chief operating officer at Fidelity.

Reynolds credited Fidelity’s chairman, Edward C. Johnson, with pushing the clearinghouse approach inside Fidelity and in industry circles.

In early October, Johnson chose Janice Morris-Hatch, a partner for operations at Fidelity Ventures, the venture capital arm, as the project leader. Morris-Hatch began researching whether a clearinghouse for fund trades could be created.

She soon linked up with Ann E. Bergin, a managing director at Depository Trust and Clearing. “I was a little confused when I first heard about their idea for a clearinghouse, so I called,” Bergin said. “And they said, ‘No, no, you’re what we’re thinking of.’ We have been working together ever since.”

As those at Fidelity see it, the late-trading cases that have arisen in the scandal illustrate how important it is to have the time stamps in the firm grip of a neutral, regulated entity.