- The Washington Times - Wednesday, September 3, 2003

NEW YORK (AP) — A hedge fund gained unfair trading privileges at several big-name mutual fund companies in an illegal arrangement that law-enforcement officials say is widespread and could be costing investors billions of dollars.

Canary Capital Partners LLC, a multimillion-dollar hedge fund, and its managers agreed to pay $30 million restitution for illegal profits generated from unlawful trading and a $10 million penalty, New York Attorney General Eliot Spitzer said yesterday.

In exchange for big-money investments, Mr. Spitzer said, several mutual funds bent the rules applied to most investors and allowed Canary to make after-hours trades and short-term “in and out” deals. Canary arranged to make such trades with several leading mutual fund families — including Bank of America’s Nations Funds, Banc One, Janus and Strong.

Mr. Spitzer said his investigation, begun earlier this year, would continue and it was “a near-certainty” that other mutual funds would be named.

The probe has “opened up a window on some of the practices used by the mutual funds that are detrimental to mom and pop investors,” he said.

Under the settlement, Canary did not admit or deny wrongdoing, and its officers agreed to cooperate with the investigation of the mutual fund industry.

A statement from the firm said it agreed to the settlement “to avoid protracted and complex litigation.” Its manager, Edward J. Stern, agreed not to trade in mutual funds or manage any public investment funds for 10 years.

A Strong capital spokesman said the firm was fully cooperating with Mr. Spitzer’s office. A spokesman for Bank One, the parent company of Banc One Investment Advisors, said the firm had just learned of the issue yesterday morning and would cooperate fully. There was no immediate comment from the other two firms.

Mutual fund companies state in their prospectuses that they discourage or prohibit “late trading” and short-term “market timing” by large investors. But Mr. Spitzer’s investigators found evidence that mutual fund managers permitted certain companies to conduct such trades in exchange for payments and other inducements.

At a news conference, Mr. Spitzer displayed e-mails and documents in which the firms discussed the schemes. In an April 2 e-mail exchange over whether questionable trades should be allowed, a senior official at Janus wrote, “I have no interest in building a business around market timers, but at the same time I do not want to turn away $10-$20 million. How big is the … deal?”

Mr. Spitzer added that the fees garnered by the mutual funds in return for allowing the trades were substantial — Bank of America documents showed the firm estimated it made $2.25 million per year from such relationships.

Late trading involves purchasing mutual fund shares at the 4 p.m. price after the market closes — a practice equivalent to “betting on a horse race after the horses have crossed the finish line,” Mr. Spitzer said. Late trading is prohibited by New York’s Martin Act and Securities and Exchange Commission regulations.

Late trading by fund managers could cost individual mutual fund shareholders millions in lost appreciation value, said John Collins, spokesman for the Investment Company Institute, the Washington trade association for mutual funds.

“The trader would have appropriated assets from the mutual funds that rightfully belong to the shareholder,” Mr. Collins said.

SEC Chairman William Donaldson condemned the conduct as “reprehensible.”

“Today’s action further illustrates the importance of the SEC’s ongoing review of both hedge funds and mutual funds and the SEC’s upcoming recommendations regarding improvements and increased disclosure requirements for both,” Mr. Donaldson said in a statement.

Marguerite Higgins in Washington contributed to this report.

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