The growing mutual fund scandal hit Prudential Securities Inc. Tuesday as five former brokers and two former Boston branch managers were accused by regulators of improper trading, some of itallegedly hidden behind dummy names and numbers.
The regulators painted a disturbing portrait of an operation where brokers dodged rules barring market-timing by concealing their identities with intentionally misspelled names and false identification numbers – then racked up millions of dollars in commissions and profits for hedge fund clients.
Market timing trades – short-term, in-and-out buying and selling – are not illegal, but the civil complaints by the Securities and Exchange Commission and Massachusetts Securities Division allege that the techniques used to evade mutual fund companies trying to shut down the brokers amounted to civil fraud.
The complaints also suggested that some unidentified mutual fund company employees may have undermined their own firms’ prohibitions on market timing by tipping off the brokers on how to avoid detection by the fund companies.
Prudential, now controlled by Charlotte, N.C.-based Wachovia Corp., was not named in the complaints, though it is expected to be added as a defendant later, and was deeply implicated in the allegations outlined Tuesday. Authorities claimed Prudential received as many as 30,000 warning letters from at least 68 mutual fund companies trying to halt such trading in their funds but did not take appropriate action.
Prudential is the latest company to have executives or employees implicated in the scandal, which already forced the departure of CEOs from two other firms, Strong Mutual Funds and Putnam Investments. And the scandal is likely to keep spreading: the SEC’s enforcement chief, Stephen Cutler, told Congress on Tuesday his agency will be notifying more companies this week that they face possible charges.
The complaints against Prudential allege that management essentially approved of the market timing practices as a business venture, although Prudential later prohibited market timing in its own family of mutual funds and, in January, advised its brokers to abide by the market timing policies of mutual funds in which it invested.
The SEC complaint names former brokers Martin J. Druffner, Justin F. Ficken, Skifter Ajro, John S. Peffer and Marc J. Bilotti and former branch manager Robert Shannon. The Massachusetts complaint names Druffner, Ficken, Ajro, Shannon and Michael Vanin, also a former branch manager.
“It strikes me as a pretty heavy-handed attempt by the regulators to hold employees accountable for a strategy that was approved by the highest levels of the company,” said Gary Crossen, an attorney for Vanin. “If they want to make a rule making market timing illegal, they should implement such a rule for the future and stop trying to hold people responsible for activity that was not illegal in the past.”
Daniel M. Rabinovitz, an attorney representing Druffner, Ficken and Ajro, said his clients were cooperating and had done nothing wrong.
“How can it be deceptive conduct if everybody knew about it?” he said.
An attorney for Shannon did not immediately return message seeking comment. Vanin left the company in 2001; the others resigned under pressure last month.
Prudential spokesman Jim Gordon said: “Our only comment is we have been and continue to cooperate fully with regulators.”
The filings claim the operation at the Boston branch office generated as much as $5 million annually in commissions for the group, making Druffner, the group’s leader, one of the company’s top brokers nationwide. They claim Prudential gave the group additional staff and a fax machine to handle late-day trades, devoting so many resources that the company allegedly neglected orders from retail customers.
“Senior Prudential executives knew and encouraged this activity and were reluctant to pass up the profits generated by courting multimillion-dollar accounts,” the Massachusetts complaint said.
The complaint follows last week’s allegations that Putnam Investments, a mutual fund company, allowed some customers and employees to engage in market timing trades.
The case against Prudential, however, shows fund companies struggling to halt the voluminous trading by Prudential traders. They sent warnings and shut down Prudential accounts, but the brokers changed the spelling of their names and acquired at least 62 different financial-adviser identification numbers to disguise the volume of trades coming from a single source.
The Massachusetts complaint includes a June 7, 2002, letter from The Hartford Mutual Funds to Prudential notifying the company that some employees’ investment privileges had been terminated.
The Massachusetts complaint, however, alleges that mutual fund “wholesalers” – employees of fund companies who deal with big customers – helped Prudential brokers get around monitoring by the fund companies.
Their tips allegedly included advising brokers to keep trades under $1 million, steer business toward larger funds where the trades would be less likely to stick out, and even trade on the day after a holiday or the Friday before a long weekend when the “market timing police” would be less likely to notice.
The complaints also identified the hedge funds the Prudential brokers were trading for as Chronos Asset Management and Head Start. They were not accused of wrongdoing.
