Nov. 4–With the knowledge of their superiors, Prudential Securities brokers in the firm’s Boston office used multiple account numbers, misleading addresses, and misspelled names as part of a”fraudulent scheme to enrich themselves and their offshore hedge fund clients at the expense of mutual fund shareholders,” the Massachusetts Securities Division is expected to charge today.
A copy of the complaint was obtained by The Boston Globe.
The complaint alleges multiple violations of state securities laws by brokers Martin Druffner, Justin Ficken, and Skifter Ajro, and Boston office managers Michael Vanin and Robert Shannon. Druffner, Ficken, Ajro, and Shannon resigned in September. Vanin left the company two years ago.
According to the complaint, Prudential brokers made a multimillion-dollar business out of trading in and out of mutual funds to make quick profits at the expense of long-term investors, a practice known as market timing. Though not illegal, market timing is discouraged or prohibited by most mutual funds.
Instead of supervising brokers engaged in such activity, senior Prudential executives knew and encouraged it because they were reluctant to pass up the profits generated by courting multimillion-dollar accounts, the complaint alleged.
Lawyers for the Prudential brokers and managers disputed the allegations but said they could not comment further until they had seen the complaint.
“These charges will be vigorously defended, and we believe they will ultimately be determined to be false,” said Daniel M. Rabinovitz, the attorney who represents Druffner, Ficken, and Ajro.
Attorneys for former branch managers Shannon and Vanin also said their clients did nothing wrong.
“Any trading practices used in the branch when he was there that are now under investigation by regulators were approved at the highest level of the company, including the company’s lawyers,” said Gary Crossen, Vanin’s lawyer. “Mr. Vanin intends to vigorously defend himself until he’s vindicated.”
Shannon’s attorney, Steven Fuller, said, “The charges are clearly precipitous and not the product of a complete and thorough investigation.”
The state inquiry into the mutual fund industry has been spearheaded by the Massachusetts Securities Division, headed by Secretary of State William F. Galvin. Prudential is also the subject of an investigation by the Securities and Exchange Commission.
The trading activity that drew the securities division’s attention traces its roots to 1998 when Druffner received an unsolicited client referral from a college friend, Michael Sassano, then employed by the Canadian Imperial Bank of Commerce. One of Sassano’s clients was Chronos Asset Management, a hedge fund run by Canadian Imperial. Another was a hedge fund called Head Start.
Druffner and his colleagues opened multiple accounts on the hedge funds’ behalf in an effort to conduct market timing activity without detection, the complaint alleges. In 1999, Druffner generated $600,000 in commissions. In 2000, he added Ficken and Ajro to help him service these accounts. By 2001, the commissions grew to $1.7 million. By 2003, they were more than $3 million. The commissions were split 70 percent Druffner, 20 percent Ficken, 10 percent Ajro, the complaint alleges.
Many mutual fund companies establish screening mechanisms designed to prevent market timing, but Druffner was often tipped off by mutual fund representatives on how to evade these mechanisms, the complaint alleges.
In some cases, Druffner was advised to make trades on the day after a holiday or on the Friday before a long weekend, when scrutiny was less vigilant.
Many mutual funds establish certain thresholds for trades, so if a trade exceeds a certain dollar volume, it comes under scrutiny. But a market-timer can break up a trade into many accounts and avoid detection because they are below the threshold.
Branch managers at Prudential’s Boston office not only “failed to address the deceptive practices surrounding the market timing activity” by Druffner and his colleagues, but “actively encouraged and furthered it by enabling the representative to obtain absurd amounts” of account numbers, the complaint alleged.
To avoid detection, Druffner and his colleagues used multiple accounts, sometimes deliberately misspelling names on accounts, or using prefixes that suggested that a trade was originating from Miami or the West Indies rather than Boston, the complaint alleged. Druffner also transferred shares into a new account as a way to throw off suspicion.
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