Safeguards Against Fund Trading Violations

How CIGNA Is Protecting Sponsors and Participants

In September 2003, New York Attorney General Eliot Spitzer initiated a probe of mutual fund trading violations. Mr. Spitzer's investigation has focused on illegal late-trading and prohibited market timing practices. Similar investigations have been launched by the Securities and Exchange Commission and The Commonwealth of Massachusetts.

These are complex issues and, because investigations are ongoing, events continue to unfold daily. CIGNA is monitoring the situation and will take effective and reasonable actions to prevent improper activity and protect investors.

It is important that retirement plan sponsors, union trustees, participants and union members understand the nature of CIGNA's current and ongoing response to these events:

1. Late-trading is fraudulent and illegal; it will not be tolerated by CIGNA.
   
   
2. Frequent transfers into and out of investment options offered by CIGNA, for the purposes of market timing, will not be allowed.
   
   
3. CIGNA will monitor its funds for the presence of prohibited and/or illegal activities. We will take appropriate action when necessary.
   
   
4. We have established preventative guidelines that discourage market timing. We believe the vast majority of our participants are long-term investors. But we will restrict the trades of those participants whose trading activity is deemed not in the best interests of the fund's long-term investors.
   
   
5. International funds are the most common funds included in market timing activities. To reduce the likelihood of our international institutional sub-advised funds being used for market timing, CIGNA has adopted fair valuation pricing procedures.
   
   

What is Market Timing?

Market Timing, in its most basic form, is the practice of frequent trading in funds. It is most commonly seen in international funds. While not illegal, most fund companies have rules limiting or even prohibiting this frequent trading.

Market timing harms a fund's long-term shareholders because it permits frequent traders to take advantage of mispricing or "stale" pricing that can occur in the market, and it increases transaction costs. Both of these activities impact the overall performance of the fund.

One way to look at the impact of market timing is to use an international fund as an example. Market timing is often a 'bet' that if the United States stock market rises today, the international stock markets will rise tomorrow. History shows that while this is often the case, it doesn't always hold true. To take advantage of this, on a day that the U.S. market is rising sharply, an investor in the U.S. would purchase shares of an international fund. The next day, if the historical relationship holds true, the investor can sell the shares of the international fund for a low-risk gain.

This scenario impacts the long-term shareholders by potentially hurting performance in two main ways:

1. The rapid trading generates trading commissions and other costs, which all investors have to absorb, but only the market timer reaps the benefits.
2. As a way of handling potentially large movements of cash on a daily basis, portfolio managers may keep larger percentages of the fund in cash, instead of buying the type of investments they would prefer.

What is Late-Trading?

Late-trading is the practice of allowing an investor to choose to buy or sell a fund at a price that is not available to the general public. Late-trading is illegal.

Funds are priced only once each day at the close of the market (for a domestic fund typically 4 p.m. Eastern Time). Orders received before 4 p.m. will receive the price on that day, and orders that are received after that time are priced the following day.

Late-trading occurs when a fund, broker or other intermediary permits an investor to place an order after 4 p.m. that receives the market-close or 4 p.m. price. This would allow an investor to take advantage of information that becomes public after 4 p.m.

For example, a positive earnings release at 4:10 pm for a particular company, "Company X", that is a very large holding in a fund, "Fund Y", would likely increase the price of the fund the following day. An investor with late-trading capabilities would purchase "Fund Y" at the pre-4p.m. price, and obtain the next day's gain. Other investors would need to wait until the following day to purchase the fund. Media accounts have described situations where certain investors, such as hedge funds, have been given special opportunities to trade "after hours."

Why does this hurt long-term shareholders of Fund Y? Long-term shareholders are required to share Fund Y's gains with the late trader, thus reducing their returns.