Sep. 4–For years, a large investment firm bent the rules at some of the nation’s most prominent mutual funds, including those offered by Bank One, in an illegal arrangement that authorities say iswidespread and could be costing investors billions of dollars.
By promising hefty investments, Canary Capital Partners LLC, a multimillion dollar New Jersey-based hedge fund, persuaded the mutual funds to allow it to trade when ordinary investors could not, the New York State Attorney General’s Office said Wednesday.
On other occasions, the funds allowed Canary to speculate on market moves through rapid-fire purchases and sales of stock, a practice they told other investors was forbidden, officials said.
New York Attorney General Eliot Spitzer said his investigation, begun earlier this year, would continue and it was “a near certainty” that other mutual and hedge funds would be named.
“The full extent of this complicated fraud is not yet known,” Spitzer said. “Certain companies and individuals have been given the opportunity to manipulate the system.”
Canary Capital Partners and its founder agreed to pay $40 million in penalties and restitution, Spitzer said. Under the settlement’s terms, Canary did not admit or deny wrongdoing, and agreed to cooperate with the investigation.
The mutual funds all said they, too, were assisting investigators.
Among those named in court documents as having business ties to Canary are Bank of America, Bank One, Janus Capital Corp. and Strong Capital Management. The firms themselves are not accused of any wrongdoing and the lawsuit names only Canary, its affiliates and founder as defendants.
According to Spitzer’s office, Canary allegedly engaged in the practice of “late trading” mutual fund shares.
Mutual fund prices are set at 4 p.m. Eastern Standard Time. All buy and sell orders from earlier in the day are finalized at that time, and no trades are to be completed the next day. But in Canary’s case, the mutual funds allegedly allowed the hedge fund’s traders to buy and sell shares for several hours after the deadline.
Companies usually make big or unexpected announcements after 4 p.m., to avoid roiling the markets. Because Canary could predict the effect those announcements would have on a fund’s share price, they could trade with information not available to others.
“Allowing late trading is like allowing betting on a horse race after the horses have crossed the finish line,” Spitzer said.
Canary allegedly began late trading with Bank of America’s Nations Funds family of mutual funds after a meeting with fund executives in 2001.
The bank offered $300 million in credit to finance the trades, documents say. It also charged fees and interest.
“In the process, Canary became one of Bank of America’s largest customers,” the documents stated. “Canary made tens of millions through late trading … while the various parts of the Bank of America that serviced Canary made millions themselves.”
Securities experts said late trading is unacceptable.
“If it in fact occurred, it was strictly against the law,” said Gary Gensler, a former partner at Goldman Sachs and undersecretary at the Treasury Department during the Clinton administration.
Spitzer said Canary also was allowed to trade rapidly in and out of mutual funds on a frequent basis, even though the prospectuses of the mutual funds promised investors that it would not be allowed. This rapid-fire trading is referred to as “timing.”
Although not illegal, mutual funds typically prohibit timing because it raises transaction costs and can cause tax problems for other shareholders.
Court documents also set out how Bank One accommodated Canary.
Bank One is the corporate parent of Banc One Investment Advisors, which manages the “One Group” of mutual funds.
Legal documents say that in 2002, an intermediary introduced Canary founder Edward Stern to Mark Beeson, president of Banc One Investment. Stern explained his strategy of timing trading to Beeson, who allegedly accepted the proposal.
Bank One agreed to loan a Canary affiliate $15 million “at a high interest rate in order to finance the timing,” legal documents say.
Beeson declined to comment on the allegations.
“The prospectus for the One Group funds reassured investors that Bank One protected them from timers like Canary,” the lawsuit says.
Moreover, the prospectus said investors would not be permitted to frequently trade in and out, and in one case warned of a 2 percent redemption fee for anyone who did so.
“The redemption fees were waived for Canary,” documents say.
The relationship between Canary and Bank One soured, according to legal documents. Canary stopped its timing in Bank One funds in April.
The Associated Press and Tribune staff writer Rachel Osterman contributed to this report.
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