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Alliance Capital
On December 18, 2003, Alliance Capital Management L.P. (Alliance Capital) agreed to settle an SEC administrative proceeding for having allowed market timing in certain of its mutual funds in exchange for fee-generating investments in other Alliance Capital investment vehicles. Alliance Capital agreed to pay $250 million ($100 million penalty and $150 million disgorgement) to be distributed by the SEC to fund shareholders, and to undertake compliance and fund governance reforms to enhance the independence of the mutual funds' boards and strengthen compliance oversight. The SEC found that Alliance Capital permitted market timing in certain of its mutual funds in exchange for long-term investments in its hedge funds and mutual funds. At their height in 2003, Alliance Capital arranged over $600 million in market timing capacity in its mutual funds. Its biggest timer, Daniel Calugar, owner of Security Brokerage, peaked at $220 million of timing capacity in certain mutual funds. Alliance Capital granted Calugar $150 million timing capacity (the right to make multiple roundtrip trades up to $150 million each) in the AllianceBernstein Technology Fund in return for a $30 million investment in a hedge fund managed by the same portfolio managers. Alliance Capital also solicited shareholder approval to lift a restriction on futures trading in one of the funds without disclosing that one reason was to enable the portfolio manager to manage better the cash flows resulting from market timers. Alliance Capital also provided confidential information about the portfolio holdings of certain mutual funds to one of the timers, Canary Investment Management, enabling Canary to profit from market timing in declining markets. SEC Release Separately, Alliance reached an agreement with the Attorney General of New York to lower fees paid by fund shareholders by an estimated $250 million over 5 years. NY Press Release
Bank of America
On March 15, 2004, Bank of America reached an agreement in principal to settle with the New York Attorney General and with the SEC, alleging that Banc of America Capital Management, LLC, a fund advisor, permitted the Canary hedge fund to engage in market timing in its Nations Funds and that Banc of America Securities, LLC, a broker-dealer, facilitated market timing and late trading by Canary and others by trading through one of its brokers and by trading directly through its clearing function through an electronic link. Bank of America agreed to pay $375 million ($125 million in penalties and $250 million in disgorgement) to be distributed by the SEC to the Nations Funds and their shareholders. Bank of America represented that it will exit the securities clearing business, and agreed to implement certain election and retirement procedures for the Nations Funds trustees that will result in the replacement of the Nations Funds trustees within one year, and to strengthen compliance oversight. SEC Press Release Separately, Bank of America agreed with the New York Attorney General to reduce fees paid by fund shareholders. NY Press Release On September 16, 2003, the New York Attorney General brought criminal charges and the SEC filed civil charges against a former employee of Banc of America Securities. NY Press Release (with link to Complaint) On April 15, 2004, the Attorney General of New York announced the indictment of a former Bank of America Securities broker. NY Press Release (with link to Indictment)
Canary Capital Partners
On September 3, 2003, the Attorney General of New York reached a $40 million settlement agreement with Canary Capital Partners, LLC – a multimillion dollar hedge fund – two Canary-related entities, and Edward J. Stern, the managing principal of those entities. Canary obtained special trading opportunities with leading mutual fund families – including Bank of America's Nations Funds, Banc One, Janus and Strong – pursuant to undisclosed agreements that involved substantial benefits for the fund management companies. NY Press Release (with links to Complaint and Exhibits)
CIBC
On February 3, 2004, the New York Attorney General brought criminal charges and the SEC instituted enforcement proceedings against Paul A. Flynn, a former managing director of Canadian Imperial Bank of Commerce (CIBC), for his role in providing financing to hedge funds he knew were engaged in unlawful market timing and late trading of mutual funds. The SEC alleges that, from 2001 to 2003, Flynn negotiated and structured swaps and loan agreements that provided certain hedge fund clients of CIBC, including Canary Capital Partners, with leverage to trade in mutual fund shares even though Flynn knew that these hedge fund clients were engaged in unlawful mutual fund trading through an electronic trading platform operated by Security Trust Company, N.A. (STC). In a memorandum, Flynn described STC's "Same Day/Late Day Trading Platform and the benefits this proprietary platform brings to our Mutual Fund Market Timing Clients." Flynn's memorandum stated that clients using STC's platform "are able to submit trades for same day value" after 4:00 p.m. "based upon published Net Asset Values (NAVs)." According to Flynn's memorandum, "[A] pricing list is prepared by the company and submitted to our clients who are then able to run their timing models against actual closing prices instead of the previous day before they submit trades." Flynn's memorandum also explained that STC utilized several strategies to reduce the chance that mutual funds would detect the hedge funds' market timing and late trading: [T]he company allows our clients to submit trades in a number of methods to reduce the chance that they would appear to be timing a specific mutual fund. The different types of investing are as follows: 1) Traditional account specific fund investing keeping account balances small; 2) Using a number of multiple legal vehicles (i.e. different Tax ID numbers) they rotate the ownership of the mutual fund transferring balances between related accounts; 3) Piggy backing non-12(b)1 accounts (i.e. 401K etc.) To invest in pools of funds on a net basis as specific ownership is not known by the fund; and 4) Piggy backing 12(b)1 accounts w[h]ere a specific agreement is made with a broker to include the additional fund investments… SEC Release and NY Press Release (with link to Complaint)
FleetBoston
On March 15, 2004, two subsidiaries of FleetBoston Financial Corp. (Columbia Management Advisors, Inc. and Columbia Funds Distributor, Inc.) reached an agreement in principle to settle with the New York Attorney General and with the SEC regarding charges that they allowed certain preferred mutual fund customers to engage in short-term and excessive trading while representing publicly that such trading was prohibited. The SEC complaint (filed February 24, 2004) alleges that, from at least 1998 through 2003, Columbia Funds Distributor secretly entered into arrangements with at least nine companies and individuals allowing them to engage in frequent short-term trading in at least seven Columbia funds. The defendants agreed in principal to pay $140 million ($70 million penalty, $60 million disgorgement) to reimburse injured fund shareholders, and to undertake compliance and mutual fund governance reforms including any to be recommended by an independent compliance consultant. SEC Release Separately, FleetBoston agreed with the New York Attorney General to reduce fees paid by fund shareholders. NY Press Release The New York Attorney General had filed a complaint on February 24, 2004. NY Press Release (with link to Complaint)
Fred Alger employee
On October 16, 2003, the Attorney General of New York brought settled criminal charges and the SEC filed settled civil charges against James P. Connelly, Jr., former Vice Chairman and Chief Mutual Fund Officer of Fred Alger & Company, Inc. The SEC found that Connelly approved agreements that permitted select investors to market-time certain mutual funds managed by Alger in a manner inconsistent with Alger's public disclosures in prospectuses. NY Press Release (with link to Complaint)
Heartland Advisors
On December 11, 2003, the SEC filed civil fraud charges against Heartland Advisors, Inc., its CEO, two portfolio managers, four officers, five directors, a pricing service and one individual for misrepresentations, mispricing and insider trading in two Heartland Group high-yield municipal bond funds. The value of the Funds, and a smaller related fund, dropped by approximately $93 million between Sept. 28 and Oct. 13, 2000, when Heartland sought to correct months of deliberate mispricing. SEC Release
Invesco Funds
On December. 2, 2003, the Attorney General of New York and the SEC separately filed civil fraud charges against Invesco Funds Group, Inc. (IFG) and its president and chief executive officer alleging the defendants violated the market timing policies reflected in the funds' prospectus disclosures, and breached their fiduciary duties, by accepting investments by dozens of market timers in Invesco mutual funds to enhance the management fees earned by IFG. The SEC alleged that from at least July 2001 until October 2003, the IFG entered into arrangements to allow specific investors, termed "Special Situations," to secretly market time Invesco funds in violation of the policy disclosed in the prospectuses for the mutual funds limiting investors to four exchanges per year, with exceptions to be allowed if it was in the best interests of the funds. Despite this disclosure, IFG did not enforce its market timing policy for shareholders whose accounts were less than approximately $100,000, and IFG also allowed larger shareholders to market time the Invesco funds. The SEC alleged that defendants failed to disclose that the Special Situations existed or that IFG had a conflict of interest because the Special Situations served to increase its management fees. SEC Release and NY Press Release (with links to Complaint and Exhibits)
Janus Capital Management
On April 27, 2004, Janus Capital Management, LLC settled charges by the Attorneys General of New York and Colorado alleging that Janus entered into a series of undisclosed agreements with select investors which permitted these preferred investors, contrary to perspectus statements, to engage in improper, frequent short-term trading of Janus mutual funds. Janus agreed to pay $50 million in restitution and disgorgement and $50 million in civil penalties, as well as to reduce its fees by $125 million over a five-year period.
Lipper portfolio manager
On October 29, 2003, the SEC filed fraud charges against Edward J. Strafaci, the former portfolio manager of the Lipper convertible hedge funds, for overstating the value of the funds. Simultaneously, the Office of the United States Attorney for the Southern District of New York announced Strafaci's indictment on criminal charges arising from the same conduct. The SEC alleges that, from at least 1998 until his departure in January 2002, Strafaci knowingly and recklessly overstated the value of convertible bonds and preferred stock held by the funds, resulting in the dissemination of materially false and misleading fund valuations and performance figures. Strafaci, who managed each of the funds, resigned from Lipper & Company, L.P. in January 2002. The SEC alleges that, contrary to representations in the funds' offering materials, Strafaci valued the fund’s holdings of convertible bonds and convertible preferred stock at prices materially higher than market prices or fair value, resulting in inflated performance figures, did so without regard to prices obtained in recent sales, frequently disregarded the views of his traders that his valuations ("marks") were too high, failed to maintain records supporting his valuations, and refused to explain his marks to Lipper management when questions arose after his departure. SEC Release
MFS
On March 31, 2004, Massachusetts Financial Services Company (MFS) reached a settlement with the SEC in which MFS agreed to compliance reforms and a $50 million penalty to be distributed by the SEC to shareholders in MFS funds. The SEC found that MFS failed to adequately disclose the specifics of its "shelf-space" arrangements with brokerage firms and associated conflicts. SEC Release
MFS
On February 5, 2004, Massachusetts Financial Services Company (MFS), its chief executive officer, and its president and chief equity officer reached a settlement with the New York Attorney General, the New Hampshire Bureau of Securities Regulation and the SEC for allowing widespread market timing trading in certain MFS mutual funds in contravention of public disclosures. MFS agreed to pay $225 million ($50 million in penalties and $175 million in disgorgement) and to undertake certain compliance and governance reforms. Each of the two executives agreed to pay a $250,000 penalty and disgorge over $50,000 in ill-gotten gains derived from MFS's market timing practices. All of the money paid will be distributed by the SEC to harmed shareholders. SEC Release Separately, MFS agreed with the New York Attorney General to lower fees charged fund investors by an estimated $125 million over 5 years. NY Press Release
Millennium Partners employee
On October 2, 2003, the Attorney General of New York brought settled criminal charges and the SEC filed a partially settled administrative proceeding against Steven Markovitz, formerly an executive and senior trader with Millennium Partners, L.P., a hedge fund with more than $4 billion under management. The SEC found that Markovitz engaged in late trading of mutual fund shares on behalf of Millennium, with the assistance of certain registered broker-dealers. NY Press Release (with link to Complaint)
Morgan Stanley
On November 17, 2003, Morgan Stanley DW Inc. (Morgan Stanley) settled an SEC enforcement action for failing to disclose to its customers the conflict of interest created by the "shelf space" payments it received to sell particular mutual funds. Morgan Stanley agreed to pay $50 million ($25 million in penalties and $25 million in disgorgement and prejudgment interest) to be distributed by the SEC to certain Morgan Stanley customers. A select group of mutual fund complexes paid Morgan Stanley substantial fees for preferred marketing of their funds to Morgan Stanley customers in its "Partners Program." To incentivize its sales force to recommend the purchase of shares in these "preferred" funds, Morgan Stanley paid increased compensation to individual registered representatives and branch managers on sales of those funds' shares. The fund complexes paid these fees in cash or in the form of portfolio brokerage commissions. Morgan Stanley also failed to adequately disclose at the point of sale the higher fees associated with large ($100,000 or greater) purchases of Class B shares of certain of its proprietary mutual funds. In connection with its recommendation to customers to purchase certain Class B shares, Morgan Stanley did not adequately inform customers at the point of sale that large purchases of such shares were subject to higher fees, or that those fees could have a negative impact on customers' investment returns. As with the sales of funds in the "preferred" programs, Morgan Stanley's sales force stood to earn more on sales of Class B shares of its proprietary funds than on sales of Class A shares. The SEC also found that the conduct violated NASD Rule 2830(k), which prohibits NASD members from favoring the sale of mutual fund shares based on the receipt of brokerage commissions, and Morgan Stanley settled a related action by the NASD. SEC Release
Mutuals.com
On December 4, 2003, the SEC filed civil fraud charges against Mutuals.com, Inc., its CEO, its president, and its compliance officer, as well as two affiliated broker-dealer firms alleging the defendants improperly helped institutional brokerage customers and advisory clients carry out thousands of market timing trades and illegal late trades in shares of hundreds of mutual funds. The SEC alleges that, by September 2003, approximately 294 different mutual fund companies had banned or otherwise restricted Mutuals.com from trading in their shares. The SEC alleges that, in order to circumvent efforts to restrict their timing activities, Mutuals.com and its principals used a variety of deceptive means, such as (1) formation and registration of two affiliated broker-dealers through which they could continue to market-time undetected; (2) changing account numbers for blocked customer accounts; (3) use of alternative registered representative numbers for registered representatives who were blocked from trading by mutual funds; (4) use of different branch identification numbers; (5) switching clearing firms; and (6) suggesting that their customers use third party tax identification numbers or social security numbers to disguise their identities, so that they could continue to trade in funds from which they had been banned. With respect to late trading, the SEC charges that, at least during 2003, Mutuals.com and its affiliated broker-dealers routinely received trading instructions from customers after 4:00 p.m. EST and executed those trades as if the trading instructions had been received prior to that closing time. According to the SEC, Mutuals.com and its affiliates attempted to conceal late trading activities by omitting portions of the trading information that they were required to provide to clearing agents. The defendants have agreed to a Court-appointed Special Monitor to oversee management of the Mutuals.com Trust mutual fund pending resolution of the litigation. SEC Release
Pilgrim Baxter
On November 20, 2003, the New York Attorney General and the SEC filed separate civil actions against Pilgrim Baxter & Associates, Ltd. (Pilgrim Baxter), Gary Pilgrim, and Harold Baxter in connection with market timing of the PBHG Funds. Both Pilgrim and Baxter resigned from each of these positions on Nov. 13, 2003. The SEC alleges that the defendants permitted a hedge fund in which Pilgrim and his wife had a substantial interest, Appalachian Trails, to engage in market timing of the high profile Growth Fund that Pilgrim himself managed. The SEC also alleges that Baxter provided nonpublic PBHG Fund portfolio information to a close friend in the brokerage business, who was president of Wall Street Discount Corporation, a registered broker-dealer, and the friend then passed this information to Wall Street Discount customers who used the portfolio information to market time the PBHG funds and to exercise hedging strategies through other financial and brokerage institutions. The SEC alleges that Appalachian Trails and Wall Street Discount, along with more than two dozen others, engaged in extensive exchanges in and out of the PBHG funds with the defendants' knowledge and consent, notwithstanding the published limitation of four exchanges per year, with peak market-timing assets at close to $600 million. In the Summer of 2001, defendants halted trading and redeemed the shares by all of the market timers except Appalachian and Wall Street Discount, which were permitted to continue their trading through the end of 2001. Neither Pilgrim nor Baxter disclosed that Pilgrim had an extensive financial interest in Appalachian and that Appalachian had been permitted to implement its trading strategy in PBHG funds. In 2000 and 2001, Appalachian allegedly profited by more than $13 million from its trading, $3.9 million of which was Pilgrim's share. NY Press Release (with link to Complaint)
Prudential Securities employees
On November 4, 2003, the SEC filed a civil fraud action against five brokers and one branch manager employed by Prudential Securities, Inc. (until September 2003) in connection with their market timing trades in mutual funds. The SEC alleges that, from at least 2001 through September 2003, in connection with thousands of market timing trades after the mutual funds had restricted further trading, defendants misrepresented their identities or the identities of their customers by using multiple broker identification numbers and brokerage accounts. SEC Release
Putnam
On April 8, 2004, Putnam Investment Management LLC reached a final settlement with the SEC and agreed to pay a $50 million civil penalty and $5 million in disgorgement to be distributed to investors harmed by the market-timing trading. The SEC found that Putnam failed to disclose improper market-timing trading by its portfolio managers. SEC Release Simultaneously, Putnam agreed to pay an additional $55 million in a settlement with Massachusetts regulators. On November 13, 2003, Putnam agreed to make corporate governance, compliance, and ethics reforms. SEC Release Securities fraud charges remain pending against two Putman employees, portfolio managers Justin M. Scott and Omid Kamshad, who are charged by the SEC with excessive short-term trading of Putnam funds in their personal accounts.
Security Brokerage
On December 23, 2003, the SEC filed civil fraud charges against Security Brokerage, Inc. and its president and majority owner, Daniel Calugar, for improper late trading and market timing, alleging that from at least 2001 to 2003, Calugar’s improper late trading and market timing, principally through mutual funds managed by Alliance Capital Management and Massachusetts Financial Services (MFS), yielded Calugar $175 million in ill-gotten gains. SEC Release
Security Trust Company
On November 25, 2003, the SEC filed a civil action against Security Trust Company, its former chief executive officer, its former president, and its former senior vice president for corporate services (and the New York Attorney General filed civil charges against the three individuals) for facilitating and participating in fraudulent mutual fund late trading and market timing schemes by a group of related hedge funds. The SEC's action was brought contemporaneously with related actions by the New York Attorney General and the Office of the Comptroller of the Currency. STC effects mutual fund trades for participants in retirement plans and processes data regarding those trades for the plans' third party administrators, and the SEC alleges that, from May 2000 to July 2003, STC facilitated hundreds of mutual fund trades in nearly 400 different mutual funds by several hedge funds known as the Canary Capital funds. Approximately 99% of these trades were transmitted to STC after the 4:00 p.m. EST market close; 82% of the trades were sent to STC between 6:00 p.m. and 9:00 p.m. EST. The hedge funds' late trading was effected by STC through its electronic trading platform, which was designed primarily for processing trades by retirement plans. The SEC alleges that STC misrepresented to mutual funds that the hedge funds were a retirement plan account. Retirement plans required several hours after the market closed to process trades submitted by plan participants before market close, while hedge funds did not. Over three years, defendants concealed the hedge funds' market-timing activities by:
"Shotgun" method -- STC employees opened accounts for the Canary hedge funds with numerous mutual funds to be traded through STC. The hedge funds then effected trades through these accounts to determine which funds would not detect or actively police timing.
"Omnibus" method -- STC opened five omnibus accounts for the Canary hedge funds at STC through which the hedge funds' trades were rotated in an attempt to evade detection by the mutual funds.
"Taxpayer ID" method -- STC opened mirror accounts for the five omnibus accounts using STC's taxpayer identification number. This approach sought to impede efforts by mutual fund companies to detect market timers by their tax ID numbers.
"Piggybacking" method -- STC set up a sub-account within the account of one of STC's clients and attached the Canary hedge funds' mutual fund trades to the trades of this client without its knowledge. The mutual funds that the hedge funds traded through piggybacking had previously rejected the hedge funds for market timing, and the hedge funds hoped they could continue to trade these funds under the name of another STC client.
The SEC's alleges that STC had a compensation arrangement with the hedge funds that included as large as a 1% custodial fee (STC charged most of its TPA clients a custodial fee of just .10%) and a 4% profit sharing arrangement with respect to most of the hedge funds' trades. STC received approximately $5.8 million in direct compensation from the hedge funds. SEC Release and NY Press Release (with link to Complaint)
On December 9, 2003, Nicole McDermott, former vice president of corporate services at STC, and one of the defendants in the STC action, pleaded guilty in a related criminal action in a New York State court. McDermott settled the civil charges in February 2004. SEC Release
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