1. Allocation of trades among sister funds When a single investment manager is responsible for a number of funds, the tradingfunds usually is consolidated in a single trading department or trading desk. Maintaining multiple trading desks for separate funds would be expensive and inefficient for the management firm, besides raising questions from a fiduciary perspective. If trading is not pooled, it might be difficult for the investment manager to avoid favoring one fund over another in trading a given stock. If trades for one fund were completed ahead of trades for another fund, the later trading fund would have to bear the market impact of the earlier-trading fund.

Because trades from multiple funds in the same complex are bunched together for execution, the complex must have a procedure for allocating the executed trades to the participating funds in a way that is fair.There are several different types of rules that usually are considered to produce fair allocations. One such rule allocates executed trades in proportion to order sizes. Another rule, often applicable to purchases, allocates trades in proportion to the asset size of the respective funds, subject perhaps to a de minimis exception to protect the smallest funds from being precluded from obtaining a meaningful share in a bunched trade.A third rule might take into account the timing of the orders, giving priority to the funds that provided the earliest orders to the fund trader in the course of a trading day.

FundsWhile there is no universal rule specifying allocation procedures, it is the responsibility of the fund manager to establish a fair set of allocation rules. Otherwise, the possibility of favoring one fund over another may allow the adviser to place its own interests ahead of those of the shareholders—for example, by allocating “hot” initial public offering shares to the fund with the highest management fee. For this reason, the independent directors of sister funds, as part of their oversight of trading carried out for the funds, typically review the allocation policies followed by the funds‘ traders and approve any proposed changes to those policies.

  1.  Interfund trades While sister funds may compete with one another in bunched trades in some cases, in other situations they may help reduce their costs and obtain better prices for their trades by entering into trades directly between or among themselves—without using any broker-dealer or going to any market center. Such trades are called crosses or interfund trades. Let’s take a simple illustration from a fund complex that gives each portfolio manager full responsibility to select securities (i.e., the complex does not have an approved list of securities). If the portfolio manager of Fund A sends the trading desk an order to sell 40,000 common shares of General Electric at 90, and soon afterward a different portfolio manager for Fund B in the same complex sends the trading desk an order to buy 40,000 common shares of General Electric at 90.20, the trader may “cross” the two orders at the last reported price of an NYSE trade (e.g., at 90.10). In such a cross, neither fund pays any brokerage commissions, and both funds save 10 cents per share on the bid-ask spread.

Such interfund trades are permitted under SEC rules as long as no commission is paid to any broker and the price at which the trades are executed corresponds to the last independent price at which a trade in the relevant security has been carried out in the trading day; or, if no independent trades have occurred on that day, the price is midway between the highest independent bid and lowest independent offer. Consistent with the approach taken by the SEC to other potential conflict of interest situations, SEC rules governing interfund trading require a fund’s board of directors to adopt procedures to govern such trading and to make quarterly determinations that such inter- fund trades meet the conditions in these rules.

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