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Human–Computer Interaction, Incentive-Conflicts and Methods for Eliminating Index Arbitrage, Index-Related Mutual Fund Arbitrage and ETF Arbitrage

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Indices, Index Funds And ETFs

Abstract

Around the world, Index Arbitrage and ETF Arbitrage remains a major problem (this chapter does not cover the arbitrage of Mutual Funds). The US Congress and many governments have attempted to tackle these problems and have enacted various laws which have not been effective. Index Arbitrage and ETF Arbitrage don’t facilitate price discovery, they amplify volatility and financial instability and distort indices and the perceptions of the true values and risks of companies. This chapter contributes to the existing literature by: (i) introducing new adverse effects of Index Arbitrage and ETF Arbitrage, (ii) introducing new methods for eliminating Index Arbitrage and ETF Arbitrage, (iii) introducing new theories-of-liability and causes-of-action against perpetrators of Index Arbitrage and ETF Arbitrage.

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Notes

  1. 1.

    See: How the ETF Arbitrage Pricing Mechanism Works. http://www.ifa.com/archives/articles/spence_john_20020603_how_the_etf_arbitrage_pricing_mechanism_works.asp

    See: Driebusch, C., Vaishampayan, S. & Josephs, L. (Sept. 13., 2015). “Wild Trading Exposed Flaws in ETFs – Managers of exchange-traded funds, such as BlackRock, work to find out what caused disruptions on Aug. 24”. Wall Street Journal. http://www.wsj.com/articles/wild-trading-exposed-flaws-in-etfs-1442174925

  2. 2.

    See the comments in Zitzewitz (2003), Haslem (2008), Donnelly and Tower (2007), Birdthistle (2008), Boudoukh et al. (2002), Houge and Wellman (2005), and Greene and Hodges (2002), about the ethics of Index Arbitrage. Lerman (2003), Frino et al. (2005), Chen and Singal (2006), Clarke et al. (1994), Dash (2002), Blume and Edelen (2004) studied index and ETF dynamics.

  3. 3.

    See: http://www.indexfunds.com/PFarticles/20000224_etfwhite_adv_veh_JN.htm

    See: Disclosure Regarding Market Timing and Selective Disclosure of Portfolio Holdings, 68 Fed. Reg. 70,402, 70,408 (proposed Dec. 17, 2003) (to be codified at 17 C.F.R. pt. 239).

    See generally, iShares, http://www.ishares.com/home.htm (last visited Apr. 15, 2008).

    See: http://www.sec.gov/news/speech/1987/100687ruder.pdf

  4. 4.

    See: http://cssanalytics.wordpress.com/2009/07/27/differential-dv2-and-etf-arbitrage/

    See: http://news.morningstar.com/articlenet/article.aspx?id=283302

  5. 5.

    See: Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. __ (2011; US Supreme Court).

  6. 6.

    Section 10(b) of the Securities Exchange Act of 1934 provides as follows:

    It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of inter-state commerce or of the mails, or of any facility of any national securities exchange—

    (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement (as defined in section 206B of the Gramm-Leach-Bailey Act), any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors……

  7. 7.

    Pursuant to its authority granted by Congress in the Exchange Act, the US SEC promulgated Rule 10b-5 as follows:

    It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange,

    1. (a)

      to employ any device, scheme, or artifice to defraud,

    2. (b)

      to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

    3. (c)

      to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security…

  8. 8.

    See: Touristic Centers vs. Trane, 2009 US Dist. LEXIS 106145 at 69 (DNJ, Nov. 2009) (economic loss doctrine). See: DiPlacido v. CFTC, 2009 U.S. App. LEXIS 22692 (2d Cir. Oct. 16, 2009) (uneconomic trading doctrine).

  9. 9.

    See Danielsson et al. (2005), King and Maier (2009), Garbaravicius and Dierick (2005), Arnoldi (2016), and Franzoni and Gianetti (2017).

  10. 10.

    See Investment Company Institute (2003). “Request for Rulemaking Concerning Soft Dollars and Directed Brokerage” (Letter To The US SEC). https://www.sec.gov/rules/petitions/petn4-492.htm

    See Kenmar (2005). “Concept Paper 23-402 Best Execution and Soft Dollar Arrangements” (Letter to the Securities Commissions of British Columbia, Ontario, Manitoba and Alberta in Canada). http://www.osc.gov.on.ca/documents/en/Securities-Category2-Comments/com_20050405_23-402_kenmar.pdf

    See ACA Compliance Group & Investment Adviser Association (2018). 2018 Investment Management.

    Compliance Testing Survey – June 14, 2018. https://higherlogicdownload.s3.amazonaws.com/INVESTMENTADVISER/aa03843e-7981-46b2-aa49-c572f2ddb7e8/UploadedImages/publications/2018-Investment-Management_Compliance-Testing-Survey-Results-Webcast_pptx.pdf

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    Michael I. C. Nwogugu

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Nwogugu, M.I.C. (2018). Human–Computer Interaction, Incentive-Conflicts and Methods for Eliminating Index Arbitrage, Index-Related Mutual Fund Arbitrage and ETF Arbitrage. In: Indices, Index Funds And ETFs. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-137-44701-2_9

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