Dec. 5–Mutuals.com Inc., a Dallas investment adviser, helped its clients engage in improper trading with hundreds of mutual funds, the Securities and Exchange Commission alleged in a civil fraudcomplaint filed Thursday.
The company helped some of its larger institutional clients — mainly hedge funds — carry out thousands of improper trades in other firms’ mutual fund shares, the SEC said.
“The defendants used a whole host of methods to try to mask their illegal market timing and late trading,” said Stephen M. Cutler, director of the SEC’s enforcement division. “This illustrates the lengths to which the defendants were willing to go to continue enriching themselves at the expense of long-term mutual fund investors.”
Mutuals.com chief executive Richard Sapio, 37, of Dallas was named in the complaint, along with the company’s president, Eric McDonald, 35, of DeSoto, and compliance officer Michele Leftwich, 35, of Dallas. They would not comment, but company attorney Stephen Topetzes of Washington, D.C., said his clients “intend to contest vigorously the claims and allegations” made by the SEC.
“We look forward to having those allegations evaluated in a more thoroughly developed, factual context,” Mr. Topetzes said. “We were hopeful to resolve this matter before a complaint was filed.”
The SEC said it initially detected misconduct during an examination of Mutuals.com in October. It is seeking a permanent injunction against Mutuals.com from further securities law violations, an unspecified fine and the “disgorgement of illicit profits.” Those profits amounted to about $4 million, an SEC spokesman said.
The case, filed in U.S. District Court in Dallas, is one of several brought this year by state and federal regulators in an effort to stop improper trading practices in the mutual fund industry. As in previous cases, the improper practices involved late trading and market timing.
Late trading permits favored clients to buy mutual fund shares after the market’s close at 3 p.m. Dallas time and still get that day’s closing price. If positive news breaks after the close in the technology sector, for example, the client can simply buy shares in a technology mutual fund and watch the share price rise the next day.
In most of these recent investigations, mutual fund firms have been accused of letting favored clients buy shares of the firms’ own funds after hours, at the expense of their other customers.
In this case, the SEC alleges that during 2003 Mutuals.com and two of its affiliated broker-dealers — Connely Dowd Management Inc. and MTT Fundcorp Inc. — routinely received trading instructions from customers after the markets closed but falsely told mutual fund companies that those orders had been received before the close. Connely Dowd and MTT Fundcorp were also charged in the complaint.
The other improper trading practice, market timing, involves short-term trading, typically in international funds. With this strategy, a trader buys shares of an international fund before the U.S. markets close, then typically sells them the next day.
This can be profitable because an overseas company may release a positive earnings surprise after the European markets close but while the U.S. markets are still open. Traders are almost assured of making a profit when the fund is priced the next day. Most mutual funds have policies against letting customers engage in such short-term trading.
Between July 2001 and September 2003, the SEC alleges, numerous mutual fund companies warned Mutuals.com that its market timing activities were improper. To circumvent efforts to restrict this activity, Mutuals.com “used a variety of deceptive means,” the SEC said.
For example, it formed two affiliates to practice market-timing undetected; it changed account numbers for blocked customer accounts; and it suggested that customers use third-party tax identification numbers to disguise their identities, the SEC alleges.
Spencer Barasch, associate district administrator in the SEC’s Fort Worth office, said Mutuals.com had 18 institutional and hedge fund clients.
“Most of the services provided for these 18 clients involved assisting them in market-timing and late-trading mutual funds,” Mr. Barasch said.
So far none of the clients of Mutuals.com has been charged. Mr. Topetzes, the attorney for Mutuals.com, said the company didn’t solicit the trades from the clients.
“The company was directed by the institutional clients,” he said. “It was an order taker.”
In addition to being an investment adviser to the 18 clients, Mutuals.com was also an adviser to the Mutuals.com Trust mutual fund. The SEC found no improprieties in the management of this fund.
“The company’s operations and services will continue undisturbed,” Mr. Topetzes said.
However, the SEC has asked a federal judge in Dallas to appoint a special monitor to oversee management of the mutual fund, pending resolution of the litigation.
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(c) 2003, The Dallas Morning News. Distributed by Knight Ridder/Tribune Business News.
