Feb. 4–Federated Investors said yesterday it had fired one employee and punished five others in connection with questionable mutual fund trading. The company also said it would pay $7.6 million toinvestors who may have been harmed by the activity, but doesn’t know when, how or to whom the money will be distributed.
Spokesman J.T. Tuskan estimated the restitution would amount to less than 1 cent for each fund share the affected investors own. It hasn’t been determined whether the money will go into the funds or be paid to shareholders. “I can’t tell you how many investors or how many funds,” Tuskan said.
The payout and other expenses related to the investigation will result in a $20 million charge against fourth-quarter results, the company said. The price tag could go even higher if Federated is fined by government regulators or if courts order it to compensate investors who have sued over its trading practices.
The actions taken against Federated employees, including two Federal fund managers who made trades totaling about $760,000 in mutual funds they managed, bring to nine the number of employees at the Downtown mutual fund giant who have been punished, including two who were fired and two who resigned.
The other five, including the fund managers who traded in their own funds, have kept their jobs but were hit with what Tuskan characterized as “serious penalties.” He declined to identify the employees or say how they were punished.
“It’s still hard to grasp what’s been going on. I’d like to still see some more transparency,” said Kerry O’Boyle, a mutual fund analyst with the investment research firm Morningstar.
Investors who own Federated’s stock shrugged off the news, with the shares closing yesterday at $31.91, up 71 cents.
Federated wasn’t the only one making headlines regarding the scandal that has shaken the $7 trillion industry.
New York Attorney General Eliot Spitzer arrested Paul A. Flynn, a former managing director of Canadian Imperial Bank of Commerce, yesterday on fraud and other charges for his role in financing illegal mutual fund trading by Canary Capital Partners, a hedge fund operator that did business with Federated and others. The Securities and Exchange Commission also sued Flynn, 46.
“We are committed to punishing not just those who engaged in the trading, but also those who facilitated it,” said Stephen Cutler, director of the SEC’s enforcement division.
Federated said it continued to cooperate with the SEC and Spitzer, whose pursuit of Canary spawned the industrywide probe.
Also yesterday, Amvescap, the world’s largest publicly traded mutual fund manager, took a fourth-quarter charge of $41.9 million to cover legal and other expenses related to the investigation of its Invesco funds. The amount does not include settling with regulators or compensating shareholders. Earlier, Marsh & McLennan, Putnam’s parent, paid out $24 million during the fourth quarter for expenses related to the scandal, including restitution to investors.
Federated, which manages $198 billion, took the steps after a review of its operations by Cornerstone Research. The consulting firm did not review purchases and sales of Federated funds handled by brokerage firms and other third parties, trades Tuskan said account for the vast majority of transactions involving Federated funds.
The company disclosed in November that it was guilty of two practices drawing regulatory scrutiny.
The first, known as late trading, is illegal. It involves allowing investors to buy or sell mutual funds after the market’s 4 p.m. close at the previous day’s price. The practice has been compared with letting people bet on yesterday’s horse race.
Federated employees were among those placing those bets. The company said it fired one employee who regularly placed orders after the funds’ closing times between January 1999 and March 2003. The investments ranged from $26,000 to less than $100, the company said.
Another employee accepted a Federated’s officer late order for investing about $52,000, the company said. The officer has repaid the difference between the price paid for the fund shares and the price that should have been paid and has been punished, Federated said.
The second type of trading is not illegal, but hurts small investors in several ways, including driving up fund expenses. It involves investors who move quickly in and out of mutual funds in order to get a jump on market trends.
Federated disclosed yesterday that it received $420,000 in fees from Canary, which was allowed to hop in and out of six Federated stock funds in exchange for investing about $10 million in a short-term fund Federated managed. Canary earned about $4.9 million on the frequent trading, Federated said.
“It’s kind of a quid pro quo,” O’Boyle said. “It seems the amount [Federated is] earning on these assets is just a drop in the bucket. It’s very short-sighted.”
The two fund managers who made frequent trades in funds they managed sold fund shares they purchased within nine to 76 days of their purchases. The investments were part of their 401(k) retirement accounts, which many financial advisers say shouldn’t be used for frequent trading.
Federated said both fund managers were sanctioned even though there are no regulations prohibiting such trades, and Cornerstone determined the trades had no material impact on the funds.
The company said it will now require company officers and investment personnel to hold personal investments in Federated funds for at least 60 days before selling.
Federated has been using about 400 employees in Pittsburgh and suburban Boston to process fund orders taken directly from customers. It intends to give the work to Boston Financial Data Services, a unit of State Street Bank & Trust. Although Boston Financial will begin handling orders by June 30, Tuskan said the current offices would remain open through at least December 2005.
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