Nov. 21–Gary L. Pilgrim and Harold J. Baxter defrauded investors in their PBHG funds, the Securities and Exchange Commission and New York state attorney general alleged yesterday in simultaneouscivil actions.
The complaints accuse the founders and their mutual-fund firm, Pilgrim, Baxter & Associates in Wayne, of giving their friends trading access and information that the firm denied to other shareholders.
The allegations against Pilgrim and Baxter mark the first time that the spreading national investigation of mutual funds, which began this year, has ensnared local fund executives. The two men were forced to resign last week.
They founded PBHG in 1982, turned it into a hot group of funds focused on aggressive growth, and sold it at the top in 1995. A subsequent buyer, Old Mutual P.L.C., paid Pilgrim and Baxter $400 million, including $69 million as part of their early retirement.
At PBHG, favored investors, including a private investment fund in which Pilgrim was an investor, “were allowed to ‘time’ PBHG funds” in 2000 and 2001, said the complaint filed in New York by Attorney General Eliot Spitzer. The fund primarily used in the market-timing scheme, PBHG Growth, was managed by Pilgrim.
Fund-timers take advantage of the lag time between the appreciation of individual stocks and early-evening repricings by funds that own those stocks.
Last-minute investments siphon off gains that would go to long-term investors. In addition, the timers run up trading costs paid by ordinary investors, and trigger tax gains for the fund.
In the case of one of those investors, “Baxter improperly provided nonpublic portfolio information” to a friend who headed a discount brokerage firm, the SEC said in its suit, which was filed in federal court in Philadelphia.
Pilgrim, 63, and Baxter, 57, did not return calls to their homes yesterday.
In a statement, the firm said that “historical conduct” fell short of the firm’s standards, but that it disagreed with parts of the allegations.
“It’s serious,” said Paul Herbert, who covers PBHG for Morningstar, the Chicago research firm. “There have been relatively few charges despite all of the names being thrown around.”
Spitzer rocked the investment industry Sept. 3 when he announced a $40 million settlement with Canary Capital Partners L.L.C., a New Jersey hedge fund that received favored treatment from four mutual funds.
Subpoenaing Canary’s records, Spitzer found the hedge fund had a “trading relationship” with PBHG. His office subpoenaed PBHG records in July.
Regulators bridled at the firm’s handling of the resignations last week of Pilgrim as president and Baxter as chairman.
At that time, the company said Pilgrim and Baxter had not broken the fund family’s rules. Local SEC official disagreed yesterday.
“They absolutely acted in contravention” of the PBHG’s limit of four exchanges a year between funds, said David S. Horowitz, an SEC assistant administrator in Philadelphia.
PBHG allowed one timer to switch “almost weekly,” Horowitz said.
PBHG moved twice internally to curb timing activity, according to documents cited by Spitzer. The fund family began enforcing the four-exchange limit in 1998, ultimately identifying about 100 timers.
Even so, by late summer 2001, PBHG’s timing task force was describing their work as engaging in a “war on financial terrorists (a.k.a. timers),” according to Spitzer’s complaint. PBHG identified 28 timers and banned 26.
The fund family made exceptions for Appalachian Trails, a hedge fund in which Pilgrim was an investor, and Wall Street Discount Corp., a discount brokerage firm run by Alan Lederfeind, whom the SEC describes as a longtime friend of Baxter’s.
Michael Christiani, Appalachian’s manager, sought out Pilgrim in 1995 to invest in a fund that used a computer model that would alternate money between stock and bond funds.
After initially using other fund families, Christiani asked Pilgrim in March 2000 for permission to use PBHG funds. Pilgrim received Baxter’s permission, the SEC maintains. Neither informed the funds’ board of trustees.
Appalachian made $13 million in its PBHG trades in 2000 and 2001, according to the SEC complaint. Pilgrim’s take was $3.9 million.
The complaints covered familiar ground in the mutual-fund scandal, but specifics were shocking. Richard Levan, a securities attorney in Philadelphia, marveled at “the brazenness — to shut out all other timers and allow yourself and a few friends to continue.”
For his part, Baxter was providing information about PBHG Growth’s holdings to Lederfeind that PBHG was not providing to other investors.
“He was basically giving inside information about portfolio holdings to someone who could use that information for market-timing,” said Horowitz, of the SEC’s Philadelphia office.
As of July 12, 2001, 14 percent of PBHG Growth’s assets were held by the friends — Appalachian, Wall Street Discount, the brokerage’s clients and other timers.
New York Attorney General Spitzer, testifying to the Senate Banking Committee yesterday, said he was “delving into” cases like Pilgrim Baxter, in which there is “dual interest in a hedge fund and a mutual fund.”
Simultaneous investment or management “creates very difficult, complex tensions that are often very difficult for people to mediate or temptations that they cannot resist,” Spitzer said.
At the Financial Analysts of Philadelphia, where Pilgrim is a member, “we’re all concerned as an industry,” said Walter V. Haslett Jr., its president. Spitzer’s probe “casts a shadow on those who aren’t engaged in those practices.”
Analysts expect the allegations to hurt PBHG, which employs 120 in Wayne. PBHG funds are a common growth option in 401(k) plans. The investment company’s SEC disclosures identify the United Nations, the New York state deferred compensation plan, and TRW auto-parts company among its institutional customers.
“In a hot and cold area [of investing] like aggressive growth, there’s some solace that your manager is suffering along with you,” said Herbert, of Morningstar.
“Here [Pilgrim] is sitting it out on the rough days while you are losing money,” he said.
—–
To see more of The Philadelphia Inquirer, or to subscribe to the newspaper, go to http://www.philly.com
(c) 2003, The Philadelphia Inquirer. Distributed by Knight Ridder/Tribune Business News.
OML, NOC,
