Jan. 16–When New York Attorney General Eliot Spitzer broke open the mutual fund trading scandal last September, MFS Investment Management sent a letter to brokers expressing shock at the discovery.
“Recent disclosure of the investigation of a hedge fund’s trading practices and market timing of mutual funds has been surprising and unsettling to us all,” wrote Jeffrey L. Shames, MFS chairman, and Martin E. Beaulieu, director of distribution of Boston’s third-largest mutual fund company.
In fact, according to an MFS e-mail, senior executives at MFS — including Beaulieu — had known for months their firm allowed many large investors to market-time shares of MFS mutual funds. MFS sought to cap the amount of market-timing money pouring through its funds in May 2003. But it didn’t take any steps to eliminate the activity altogether, according to the e-mail, which was obtained by the Globe from a law firm representing a former MFS client. “Hi everyone,” wrote James V. FitzGerald, president of MFS Fund Distributors, the firm’s sales arm, in the May 14th e-mail that went to salespeople and several top executives. “Effective immediately, MFS will not be taking any new money from market timers. We currently have approximately $1.3 billion in known timer money at MFS.”
MFS spokesman John Reilly declined to comment. FitzGerald could not be reached.
The e-mail and other documents come to light as MFS is engaged in intensive negotiations with Spitzer, the Securities and Exchange Commission, and the New Hampshire Bureau of Securities Regulation to settle allegations of improper trading practices involving market timing and late trading, according to lawyers with knowledge of the talks. The talks could yield three separate settlements that could include a seven-figure fine and a reduction in the fees MFS charges shareholders.
MFS disclosed last month that the SEC’s Boston office was preparing to recommend the agency take civil legal action against the company. Earlier this month, MFS disclosed it was under investigation by Spitzer.
An SEC spokesman yesterday said the agency could neither confirm nor deny whether any discussions were taking place with MFS.
Darren Dopp, a Spitzer spokesman, yesterday said, “Talks with MFS have made progress and we’re hopeful of a settlement in the next couple of weeks.” He said that “Spitzer would be very interested in obtaining” a fee reduction for MFS investors as part of the settlement.
A spokesman for the New Hampshire Bureau of Securities Regulation said yesterday that his office is also preparing charges. “We have notified MFS we intend to take regulatory action based on alleged fraudulent activities,” said Scott Kirby, who declined to comment on the focus of the investigation. New Hampshire is assisting an investigation launched by Massachusetts Secretary of State William F. Galvin last fall and has taken a lead role in reviewing the trading activities of several large fund companies, including MFS.
MFS claims it invented the mutual fund in 1924. Now, it is the nation’s 11th-largest fund company, with about $76 billion of mutual fund assets under management. The Boston institution is 93 percent owned by Sun Life Financial Inc. of Toronto.
The focus of the regulators’ investigations is whether MFS let investors engage in market-timed trades in violation of rules set out in the company’s prospectus statements. In a recent prospectus, MFS states: “The MFS funds do not permit market timing or other excessive trading practices that may disrupt portfolio management strategies and harm fund performance.”
Market timing is an investment strategy in which an investor rapidly buys and sells shares in mutual funds to capitalize on short-term market movements. Often, a market timer can capitalize on news that occurs late in the day and does not get reflected in the price of fund shares, which is set once a day at the close of the market. The market timer profits by buying a fund at the stale price and quickly selling it after the price adjusts.
However, such trading can drive up transaction costs because portfolio managers must buy or sell shares to accommodate the sudden inflows and outflows. Many believe that market timing dilutes profits for long-term investors.
Market timing is not illegal, although many funds institute their own prohibitions against such trading. Late trading is prohibited by SEC regulations. Late trading involves placing orders for fund shares after the 4 p.m. close of the market but getting the previous day’s price.
The May 14 e-mail shows that MFS willingly accommodated market timers despite the possible problems the trading could cause for portfolio managers and shareholders.
“As you all know, timers, no matter what their strategy, can cause unnecessary trouble to an asset management company,” FitzGerald wrote. “Consequently, we feel that MFS has more than enough of this type of money at this time.”
He continued, “Existing timers can leave their money at MFS, and continue to use our funds per the existing rules. They will be asked to not send MFS any new money.”
FitzGerald was referring to a group of 11 stock and bond funds in which MFS permitted market timers to move their money in and out quickly without restrictions. MFS executives believed those funds were large and liquid enough to handle the market-timed trades without hurting long-term investors. The arrangement, previously reported in the Globe, was halted in December when the company said it was facing possible legal action by the SEC.
The e-mail was copied to senior MFS executives including chief executive John W. Ballen, president Kevin Parke, ; Beaulieu, the director of distribution; and Paul Fichera, senior vice president and director of product development for MFS Fund Distributors.
In MFS e-mails written in August and obtained by the Globe, the company tried to limit market-timed trades and inform traders who went beyond the 11 “unrestricted funds” in which the company allowed market timing money to flow freely.
An Aug. 11 e-mail sent by Ellen F. Bradley, MFS vice president of management services, cites five trades in different state municipal bond funds for a total of $2.85 million that MFS canceled. “The client is Credit Lyonnais, a known timer, and we will not allow them to use muni portfolios,” Bradley wrote to MFS employees who deal directly with the French bank’s local broker. “You might want to let this office know that high yield funds are off-limits for timing as well and [we] will take action as required to stop excessive timing in any of those portfolios.”
Credit Lyonnais, a large French retail and corporate bank and asset manager, could not be reached for comment.
By Jeffrey Krasner and Andrew Caffrey
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