Sep. 5–Within months of striking a deal to work with Canary Capital Partners LLC, Bank of America Corp. executives were calling the relationship “controversial” and questioned some of the firm’strading practices, according to court records.
In the Canary relationship, initiated in 2001 by Bank of America broker Theodore Sihpol, the bank allowed the hedge fund to trade at prices generally not available to individual investors through so-called late trading and market timing.
In January 2002, Robert Gordon, then president of Bank of America’s capital management division, e-mailed his boss, who isn’t named in the civil complaint filed by Attorney General Eliot Spitzer in New York, asking about a “controversial” relationship with Canary.
“Is this something that you want me to continue to make exceptions for (we don’t as a general rule except(sic) market timers)?,” Gordon wrote. “The corresponding balances they give us in the funds are nice but I wouldn’t do it for that.”
Still, Bank of America’s relationship with the New Jersey-based hedge fund continued until July 2003.
Now Canary is paying a total of $40 million in restitution and fines to settle charges it engaged in illegal trading with large mutual fund companies. Charlotte-based Bank of America is named as Canary’s most extensive late trading and timing relationship, according to a complaint filed Wednesday.
Bank of America said Thursday it is cooperating with Spitzer and is also conducting its own in-house review into employees’ actions. “When we get all the facts we’ll take the appropriate action,” said spokesman Bob Stickler.
Canary, which liquidated in May, allegedly obtained special trading privileges with the mutual funds by promising to make substantial investments in funds managed by those institutions, Spitzer said.
Spitzer’s charge that Bank of America, along with Bank One Group, Janus Capital Corp. and Strong Capital Management Inc., gave special treatment to Canary marks the start of a probe into the $6.9 trillion mutual fund industry. Spitzer led an exhaustive securities probe that netted earlier this year a $1.4 billion settlement with 11 Wall Street investment banks.
The bank said Canary was the only customer it permitted to have a special arrangement for market timing its mutual funds.
“We take the integrity of the market and investors very seriously and work every day to protect the interests of our customers, shareholders and associates,” the company said in a statement.
Bank of America’ relationship with Canary spanned three years, during which the bank extended up to $300 million in lines of credit to finance late trading and market timing and accepted Canary’s investments in its own family of mutual funds. The bank also placed a special computer link in Canary’s offices for late transactions, according to the complaint.
Late trading, involving the purchase of fund shares at the 4p.m. price after the market closes, is prohibited by New York law and SEC rules because it lets a favored investor take advantage of post-market events not reflected in the share price at that day’s close. Market timing is short-term, in-and-out trading, which Spitzer says hurts the holdings of long-term investors.
Throughout 2001, 2002 and up until July 2003, Canary placed orders for hundreds of mutual funds after markets closed up to 6:30 p.m. through the electronic link that Bank of America provided.
Spitzer states that in exchange for the late trading relationship, Bank of America brokers collected a commission of 1percent of money Canary invested in mutual funds. In 2001, commissions generated $655,000 in revenue, according to an e-mail by Sihpol.
The bank manages more than $134 billion in assets under its mutual fund group, which ranks 13th in assets in the nation, according to the Investment Company Institute. The largest percentage falls under the umbrella of Nations Funds. The bank never informed shareholders of Canary’s special trading practices, the complaint says.
In 2002, the bank promised to protect shareholders as it added language to its prospectus disclosing the harmful effects of market timing. In addition, the company advised shareholders of its Nations Funds international stock mutual fund in March that they would be “wise to retain a long-term perspective” when it comes to investing and “resist efforts to time market changes.”
Shortly before Canary, led by Edward Stern, received a subpoena from Spitzer’s office in July, an unnamed bank employee, “complaining vociferously,” warned the bank’s “timing police” that Canary’s actions had become detrimental to long-term shareholders, according to the complaint.
Mutual fund companies are supposed to provide a level playing field for individual investors, industry analysts said.
Laura Lutton, a Morningstar mutual fund analyst, said Thursday she was recommending that clients stop investing in all Nations Funds because Bank of America didn’t appear to be “looking out for the little guy.”
“We’re concerned that Nations Funds were not treating all investors equally,” said Lutton, who oversees a Small Company Fund noted in the complaint.
Some large mutual fund companies have established controls to prevent after-market trading.
Vanguard Group, the second-largest mutual fund company, said they have imposed trading limits and timing cut-offs for certain funds. The fund was not implicated in Spitzer’s complaint.
While Bank of America’s activities with Canary were extensive, some analysts said the probe’s long-term effect on the bank would be minimal. Bank of America earned $9.2 billion last year on revenues of $35 billion. The bank’s asset management division, which includes mutual funds, contributed about 7.5 percent of last year’s revenues.
“You could assume a $100 million charge as the result of this and it could still have a fairly negligible impact,” said Craig Woker, a banking analyst with Morningstar. “That said, the market is reacting to some fairly disturbing news about Bank of America and how it was really bending the rules and possibly breaking the rules.”
From Spitzer’s Report
“Canary’s most extensive late trading and timing relationship was with the Bank of America. The relationship was mutually beneficial: Canary made tens of millions through late trading and timing, while the various parts of the Bank of America that serviced Canary made millions themselves. All of this activity was coordinated through the Bank of America broker who brought Canary in as a client, Theodore C. Sihpol III.”
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BAC, JNS,
