Dec. 3–New York Attorney General Eliot Spitzer, the U.S. Securities and Exchange Commission and Colorado Attorney General Ken Salazar sued Invesco Funds Group on Tuesday, claiming that theDenver-based money manager deceived its investors and failed to protect them from market-timing abuses.
Invesco Funds, which oversees about $20 billion in investor assets, denied wrongdoing and said it plans to vigorously fight the three lawsuits.
An industry watchdog described Invesco’s hard line with regulators as a high-stakes game of chicken.
“If those allegations paint a fair picture, Invesco is not going to survive,” said Mercer Bullard, chief executive officer of Fund Democracy, based in Oxford, Miss. “They will go out of business if they continue this.”
In its defense, Invesco said it took the best approach it could to the market-timing problem that has bedeviled the mutual fund industry. Invesco also called on the industry and regulators to establish clear guidelines.
Market timing is the short-term trading of mutual funds to gain quick profits. While not strictly illegal, market timing is under fire because it can harm long-term investors.
Spitzer’s complaint, filed in New York state court, and the SEC action, filed in U.S. District Court in Denver, allege that Invesco and its chief executive, Raymond Cunningham, fraudulently allowed favored customers to rapidly trade in and out of Invesco funds. That trading, the complaints allege, earned the fund group management fees but cost long-term investors millions of dollars in lost returns and added expenses.
“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,” Spitzer said.
Market-timing assets in Invesco funds totaled approximately $900 million in 2003, with the practice continuing until July, when Invesco was subpoenaed by Spitzer’s office, he said. Regulators estimate market timing cost investors $161 million.
Salazar filed a suit in Denver District Court on Tuesday, alleging that Invesco violated the Colorado Consumer Protection Act. Salazar said his action was independent of Spitzer’s filing.
“Invesco told investors that it limited its short-term trading in its mutual funds and took steps to stop market timing by small investors; all the while, it was allowing a select number of very wealthy companies and individuals to engage in market timing,” Salazar said.
The Colorado lawsuit could seek millions in damages on behalf of Invesco fund holders, said Jan Michael Zavislan, state deputy attorney general. Colorado allows a fine of $2,000 per violation of its Consumer Protection Act, and up to $10,000 per violation if a senior citizen is victimized.
Spitzer targeted the problem of late trading in mutual funds, an illegal practice, and market timing, a legal but harmful activity, in early September when he reached a settlement with New Jersey hedge fund Canary Capital.
Most fund groups targeted in the probe — including Denver’s largest mutual fund family, Janus Capital Group — have ended their market-timing agreements, suspended or fired employees involved and promised restitution to harmed investors. Janus manages about $150 billion in assets.
Houston-based AIM handles marketing for Invesco Funds. Both are subsidiaries of Amvescap Plc., the London-based money manager.
“We believe these actions are not merited,” AIM Investments chief executive and president Mark Williamson said in a response to the lawsuits. “Neither Invesco Funds Group or Mr. Cunningham engaged in wrongful conduct.” Central to Invesco’s defense is that active trading, also called market timing, is not a new practice and that Invesco tried in good faith to identify and stop harmful timing activities.
“If you read the fund prospectuses, they do leave themselves a lot of leeway to basically adapt to whatever they want to do at the moment,” said Linda Ferentchak, Denver-based spokeswoman for the Society of Asset Allocators and Fund Timers.
At the heart of the charges is not whether Invesco allowed market timing, but whether Invesco executives permitted agreements they knew would harm other investors, said Fund Democracy’s Bullard.
Citing internal company e-mails, regulators allege in their complaints that Invesco repeatedly violated its stated policy of limiting investors to four exchanges out of a fund in any 12-month period.
Yet, timers in some cases were allowed as many as 80 trades a year, according to Spitzer. Invesco CEO Cunningham ignored warnings from his employees that timing agreements, called “special situations,” were hindering portfolio managers and cutting into returns, Spitzer’s lawsuit alleges.
“Market timing is killing the legitimate shareholders of the funds,” said a letter from an Invesco executive cited in Spitzer’s complaint. The SEC suit cites internal company memos that detail why market timing was not in the best interest of the fund and its shareholders.
The Invesco Dynamics and Technology funds in particular were popular with timers.
Canary Capital, the most active of the timers at Invesco, was allowed 141 exchanges in the Invesco Dynamics Fund between June 2001 and June 2003, totaling $10.4 billion, more than twice the fund’s assets at any given time, Spitzer’s complaint charges.
The SEC complaint alleges that Invesco sold “timing capacity” and had a formal structure to allow selected traders to time specific funds, including a minimum commitment of $25 million.
Invesco will have to justify why the timing agreements, if they were legitimate, were not put in writing and shared with the directors overseeing the individual funds or with investors of the mutual funds involved.
Besides penalties, the SEC suit seeks to have Cunningham return all the salary and benefits he received from his employment at Invesco and asks the court to have the fund family account for all its market timing related profits and return them to investors.
HOW MARKET TIMING WORKS
Market timers trade quickly in and out of mutual funds, capitalizing on short-term price discrepancies to skim returns that otherwise would go to long-term investors.
The practice adds costs and complicates the job of portfolio managers who must deal with waves of money coming in and out of funds. Hedge funds, which cater to institutional investors and the wealthy, are the key timers in the most recent investigations, moving millions of dollars in and out of funds, often within a few days or weeks.
Timing is especially prevalent in international mutual funds. U.S. mutual funds set a price once a day at 4 p.m. Eastern. Foreign securities, which have stopped trading many hours earlier, can fail to reflect the most current information available in their prices, creating a window for timers to use.
Mutual funds with lightly traded securities and sector funds — funds that invest in specific industries — also are sometimes targeted by market timers.
— By Aldo Svaldi
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