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Yves Blechner Dai Nguyen Jide Olateju

The 2003 Mutual Funds Scandal. Yves Blechner Dai Nguyen Jide Olateju. February 23, 2004. Mutual Fund Scandal Timeline. Sept. 3 - New York Attorney General Eliot Spitzer announces a probe into hedge fund Canary Capital Partners LLC and four mutual funds over suspected trading abuses

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Yves Blechner Dai Nguyen Jide Olateju

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  1. The 2003 Mutual Funds Scandal Yves Blechner Dai Nguyen Jide Olateju February 23, 2004

  2. Mutual Fund Scandal Timeline • Sept. 3 - New York Attorney General Eliot Spitzer announces a probe into hedge fund Canary Capital Partners LLC and four mutual funds over suspected trading abuses • Bank of America Corp.'s ,Banc One Funds, Strong Capital Management Inc. and Janus Capital Group Inc involved • Sept. 30 - Alliance Capital (the largest publicly traded U.S. fund company) suspends two executives after finding conflicts of interest related to mutual fund trading. • Oct. 1 - 12 stockbrokers and managers at Prudential forced to resign after an internal investigation finds evidence of improper mutual fund trading.

  3. Mutual Fund Scandal Timeline • Oct. 2 - A former trader for Millennium Partners, a $4 billion hedge fund, pleads guilty to securities fraud • Oct. 2 - Smith Barney fires a broker for canceling mutual fund trades after the market's close, an illegal practice being probed by New York and federal regulators • Oct. 7 - Bank of America pledges to set up a restitution fund for holders of its Nations Funds harmed by Canary activities • Oct. 15 - James Connelly (Fred Alger Management Inc.), pleads guilty to criminal charges of evidence tampering relating to illegal trading of mutual fund shares

  4. Mutual Fund Fraud Types • Late-Trading • Bank of America, CIBC World Markets • Market Timing • Putnam, Invesco, Alliance Capital Management • Overcharging • Prudential Securities

  5. Late Trading • Allowing favored investors to trade after market-closing • Investors can take advantage of post-market-closing events not reflected in the mutual fund share price (set at the time of market-closing) • Prohibited by New York law and SEC regulations Bank of America • BOA Broker Sihpol allowed Canary Capital Partners to engage in late trading of BOA mutual funds • NY State Attorney Spitzer and SEC’s Cutler issued state criminal and federal civil charges against Sihpol • Sihpol surrendered his passport

  6. Market Timing • Detrimental to long-term shareholders: • Rapid and repeated trading of mutual fund shares can take advantage of inefficient pricing of mutual fund shares • Transaction costs for the fund increase • The stated portfolio management strategy can be disrupted • A fund can be required to maintain elevated cash positions • Result: • Possible unwanted taxable capital gains for fund shareholders • Lower long-term performance • These consequences are borne by ALL shareholders

  7. Market Timing: Putnam • Kamshad & Scott: Repeated short-term trading of Putnam mutual funds • had investment-decision responsibilities for most of those funds • traded in their personal accounts • Engaged in approx. 35 round-trip trades each • Bought and sold shares within short time period (Kamshad: 13 days on avg., Scott often on consecutive days) • Traded large amounts of mutual fund shares (often worth millions of dollars) • Realized “hundreds of thousands of dollars in gains” (SEC) • Continued to engage in short-term trading after verbal and written warnings

  8. Putnam: Detection & Resolution • Detection: • Minimal controls against short-term trading by Putnam professionals • In 2000: Senior execs. learned of “large & frequent” short-term trades -> issued warnings • April 2002: Amended the Advisor Code of Ethics • October 2003: Issued a press release disclosing the short-term trading activities • Resolution: • Putnam agreed to the entry of an order in SEC’s administrative proceeding • Agreed to undertake reforms

  9. Market Timing: Invesco • Registered in Delaware, HQ in Denver, CO • Investment advisor since 1957 • Up to $48 billion of funds under management in Mutual funds • As much as 46 (open-ended) mutual funds

  10. Invesco: Fraud Scheme • Secretly accepted funds from market timers to enhance the management fees earned by Invesco Funds Group, Inc • Market timing could detrimental to long term shareholders of the mutual funds • Prospectus stated that exchanges between funds by investors would be limited to four per year • Violated fiduciary duty by arrangements that enabling certain traders, engage in active trading of Invesco mutual funds in pursuit of so called "market timing" strategies • Failed to inform them that this market timing was being allowed. • Invesco Leadership (Cunningham) realized that market timing hurt ordinary mutual fund investors.

  11. SEC Pronouncements - Resolution • Permanent injunction prohibiting future violations • Perform accounting of fees received due to market timers • Disgorge all ill-gotten gains related to violations • For Cunningham, all benefits derived from his employment (salary, bonuses, stock, and remuneration or compensation of any kind) • Third tier civil money penalties for each separate violation of law • Permanent ban from serving or acting with respect to any registered investment company • Other equitable relief that is just and proper.

  12. Market Timing: Alliance Capital • Alliance Capital allowed some investors to market time certain Alliance mutual funds in exchange for long-term investments (“sticky assets”) in the funds. • Daniel Calugar, owner of Security Brokerage, was Alliance’s single biggest market timer. • Alliance reaped additional management fees. • Calugar is facing civil fraud charges. • Alliance, without admitting or denying wrongdoing, settled a SEC enforcement action. The terms: • Payment of $250MM, consisting of $150MM in disgorgement and $100MM in penalties. • All monies will be returned to investors harmed by Alliance’s actions. • The settlement was a record payment for this type of violation. • Alliance agreed to reduce management fees on its mutual funds by 20% over a 5-yr. period (about $350MM). • The SEC did not require Alliance to reduce fees as part of the settlement.

  13. Overcharging: Prudential Securities • Selling Class B shares without informing investors that they could receive breakpoint discounts if they purchased Class A shares. • Two Prudential Securities employees alleged to have engaged in improper sales of mutual fund shares. • Litigation against Ostrowski and Harris is still pending. • Prudential Securities settled an enforcement action by the SEC finding that the company had inadequate systems to monitor sales of different classes of mutual fund shares. • Prudential agreed to pay $82,000 in disgorgement and prejudgment interest to be returned to affected investors and a $300,000 civil penalty.

  14. Personal Fraud Story • Nigerian E-mails • Courtesy of The 419 Coalition 1. NEVER pay anything up front for ANY reason.2. NEVER extend credit for ANY reason.3. NEVER do ANYTHING until their check clears.4. NEVER expect ANY help from the Nigerian Government.5. NEVER rely on YOUR Government to bail you out. • http://home.rica.net/alphae/419coal/

  15. Resolution • Economic and Financial Crimes Commission • Warnings on every bank website. • Nigerian Investment Promotion Council • Trial of suspected Kingpins

  16. Resolution Defendants Emmanuel Ofolue (L) Emmanuel Nwude, former director of Union Bank (C) and Amaka Martina Anajemba (R) sit during their trial for fraud, in Abuja February 11, 2004. . Five Nigerians are on trial in Abuja accused of defrauding a Brazilian bank of $242 million in the 1990s

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