Late trading refers to the practice of making trades in a mutual fund after the market has closed for the day. This practice is illegal in the United States. By doing this, the investor who engages in such a practice receives an edge over investors who purchase shares in the fund not knowing what the closing price will be. The practice of late trading also allows an investor to prosper based on foreign markets and to utilize late-breaking news. This type of trading was at the heart of the 2003 mutual fund scandal, in which many of the largest mutual fund companies in the U.S. faced prosecution for their behavior.
One of the fears that grips everyday investors is that their trading will be undermined by the actions of those who possess information that the investors do not. Late trading in mutual funds is one such practice that puts the normal investor at a severe disadvantage and results in an uneven playing field. By getting prices on mutual funds that no one else can, institutional investors who engage in this practice can turn profits with virtually no risk involved.
A mutual fund is one in which funds are pooled from multiple investors, who then share in the losses and gains of the fund. The fund is managed by the mutual fund company that invests the capital within the fund among many different securities. Mutual funds are judged on the market by their net asset value, which is a measurement of the performance of all of the securities contained within the fund.
When a trader legally purchases shares in a mutual fund, he or she won't know the price of those shares until the close of trading, which, in the U.S., comes at 4:00 p.m. Eastern Standard Time (EST). If mutual fund companies allow late trading by preferred investors, those investors essentially know the net asset value of the fund in which they wish to invest. This information could be used in concert with foreign markets, which, because of time-zone differences, open and close earlier than the U.S. market and often react to its movement. In addition, this type of illegal trading allows for an investor to take advantage of sudden news that might affect a particular sector of the market.
The practice of late trading is doubly damaging to mutual fund investors who act in accordance with investment laws. Since the fund price will be affected by the actions of the late traders, the investors operating legally are essentially paying for the profits illegally gained by others. Considering that the law-abiding investors are already at a competitive disadvantage by not being privy to the closing prices, it is understandable why such an outrage was raised in the U.S. when it was revealed in 2003 that late trading practices were widespread.