Dec. 3–Federal and New York regulators filed civil complaints Tuesday against Invesco Funds Group and CEO Raymond Cunningham, the latest salvo launched in the probe of questionable trading practicesin the mutual fund industry.
The complaint accuses Cunningham and the company of encouraging traders to frequently jump in and out of Invesco funds, knowing that strategy violated company policy and siphoned profits from long-term investors.
The Securities and Exchange Commission and New York Attorney General Eliot Spitzer used e-mails and documents exchanged between Invesco’s top management to support fraud charges related to so-called market-timing activity starting in 2001 and continuing until this fall.
“The evidence in this case speaks for itself,” Spitzer said in a prepared statement. “Top managers knew market-timing was harming buy-and-hold investors, but they condoned and facilitated it because it was a lucrative source of management fee revenues.”
Cunningham became Invesco’s CEO on Jan. 1, adding that title and duties to his responsibilities as the Denver-based company’s president.
Before that, Invesco was led by Mark Williamson, who is now the chief executive of Houston-based AIM Investments, Invesco’s distributor and sister company.
In a letter to shareholders posted on AIM’s Web site late Tuesday, Williamson defended the deals Invesco struck with market timers, saying they were done to protect all shareholders by limiting timers to a few funds rather than letting them trade in any fund they chose.
And he stressed that market timing is “a lawful activity.”
“Neither IFG nor Mr. Cunningham engaged in wrongful conduct,” Williamson says in the letter. “These charges will be vigorously contested.”
Regulators seek to have Invesco return its market-timing gains and pay civil penalties.
Timing mutual funds is a rapid trading strategy that exploits share prices that do not reflect the price of their underlying assets. Although not illegal, most fund companies publicly discourage market timers from investing in their funds because it drives up a fund’s commission costs and creates other investing problems that can reduce the value of shares held by long-term investors.
Spitzer launched an investigation into the practice in July and has joined with the SEC and other state regulators in filing charges against Putnam Investments and Pilgrim Baxter & Associates for privately violating stated policies and allowing insiders or preferred clients to market time their funds.
Others that have acknowledged improper market timing inside their funds, such as Strong Financial Corp. and Alliance Capital Management, have not been charged.
However, Strong founder Richard Strong resigned Tuesday as chairman, chief executive and chief investment officer and from the company’s board of directors effective immediately.
At Invesco, its arrangements with market timers were known internally as “special situations” and the company had a written policy that “no written document identifying the agreement will be developed,” according to the SEC lawsuit filed in Denver.
However, Invesco’s fund prospectuses say investors wanting to switch funds are limited to four exchanges each year and that exceptions to that policy are only allowed if they are in the best interest of the fund and its shareholders.
The SEC and Spitzer allege Invesco consistently broke that rule in the past three years and committed fraud by using marketing material and the prospectuses containing the market-timing policy to sell heavily traded funds to long-term investors.
To back their charges, the regulators offer as Exhibit A the seven-page memorandum dated Jan. 15, 2003, that Jim Lummanick, Invesco’s chief compliance officer, sent to Cunningham.
“Activity of market timers in many of the Invesco mutual funds is at high levels,” Lummanick starts the memo. “Whether the level of such activity is acceptable is a business decision that has legal and compliance impacts.”
He goes on to say that Web sites designed for market timers identify Invesco as a “timer-friendly” mutual fund company and lists seven share classes of funds with so much short-term trading activity that their portfolio turnover rates ranged between 1,385 percent and 22,064 percent.
“Arguably, Invesco has increased its business risk by granting frequent exceptions to its prospectus policy (effectively changing the policy) without notice to shareholders,” Lumminack wrote.
He also cites an Invesco study that shows non-timed institutional portfolios produced returns 0.75 percent to 1 percent higher than the timed retail portfolios.
“Given Invesco’s mutual fund prospectus disclosure and the current level of market timing among the Invesco mutual funds, Invesco should do something in the near term, if only modifying existing prospectus language,” Lummanick concludes at the end of the memo.
Williamson says in the letter that the timing policy is not a hard rule, and Invesco sometimes limited investors to less than four exchanges each year and sometimes allowed them to do more.
“Despite this record, the charges appear to treat what IFG always intended to be a flexible guideline as if it were an inflexible policy,” Williamson says.
“The problem here is that apparently Invesco didn’t make any effort to spell out those differences to the shareholders,” says Don Cassidy, senior research analyst in Denver for Lipper, a fund-tracking company.
Canary Capital Partners, a hedge fund that has paid $40 million to settle market timing charges against it, made 141 exchanges in the Invesco Dynamics fund between June 2001 and June 2003, making it Invesco’s biggest market timer, according to Spitzer’s complaint. That fund is managed by Timothy Miller, Invesco’s chief investment officer.
The letter issued by AIM’s Williamson says, “IFG saw uncontrolled market timers as a problem to be addressed in the interests of shareholders in order to avoid the potentially harmful aspects of uncontrolled market-timing in the funds.”
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