Massachusetts regulators Thursday charged Prudential Securities with widespread late trading of mutual funds on behalf of its hedge fund customers. In a separate action, federal regulators filed civil fraud charges against investment firm Heartland Advisors, its chief executive and five other officials for allegedly defrauding mutual fund investors.
In just the past two and a half years, Prudential brokers in the firm's Boston office handled more than 1,100 late trades amounting to more than $162 million, according to Secretary of the Commonwealth William F. Galvin.
Despite company policies designed to prevent it, Prudential branch managers and executives in Boston and New York ignored the late-trading scheme, according to the complaint.
Galvin's office wants Prudential to conduct an audit to find out just how much investors lost and then pay them back. The complaint also calls for Prudential to pay an unspecified fine.
"This is yet another example of Wall Street putting the interests of favored clients ahead of retail investors," Galvin said in a press release announcing the charges "It's a dismaying but by now a familiar pattern."
A Prudential spokesman said the company had not yet been served with the complaint and had not seen any evidence supporting Galvin's allegations.
"We continue to cooperate with regulatory inquiries," said the spokesman, who added that the company would not comment on the charges until it has completed its own internal review.
Galvin said the long-running scheme violated state and federal laws and hurt fund investors by lowering returns and driving up transaction costs.
As part of the scheme, Prudential's hedge fund clients would send the Boston office a preliminary list of possible trades that were time-stamped and put aside until after the markets closed, the complaint said. After 4 p.m., those clients would telephone Prudential brokers in Boston to confirm money-making trades that were then faxed to Prudential's trading desk in New York for processing, according to the complaint.
But company policy allowed the New York desk to enter late orders only if there were problems such as a computer glitch or inadvertent human error, said Galvin.
"This scheme was clearly a violation of Prudential's internal controls," he said. "Many people knew this was going on -- and no one stopped it."
Last month, Galvin charged five former Prudential brokers with fraud in a related mutual fund market timing scheme.
Heartland fraud
In a separate action, federal regulators filed civil fraud charges against investment firm Heartland Advisors, its chief executive and five other officials Thursday for allegedly defrauding mutual fund investors by deliberately mispricing bonds in two funds.
The Securities and Exchange Commission also charged in a civil lawsuit that president and CEO William Nasgovitz and three other company executives compounded the unfairness of improper pricing by engaging in illegal insider trading in the high-yield municipal bond funds.
The recent case in the expanding investigation of the mutual fund industry involves the alleged deliberate use of so-called "stale pricing" of shares, which does not reflect their true market value.
Mutual funds generally are priced only once a day, so events that happen shortly after funds are priced for the day could cause a big swing in the following day's price. That creates an opportunity to profit for those who can manipulate the system.
Stale pricing is said to be a particular problem for mutual funds with high-risk, high-yield bond funds, such as those at issue in the Heartland case, which don't register price changes on a regular basis.
Heartland spokesmen had no immediate comment on the SEC case, filed in federal court in Milwaukee. Attorneys for Nasgovitz and other defendants couldn't immediately be reached for comment.
The SEC said the value of the two bond funds, and that of a smaller related fund, dropped by some $93 million between Sept. 28 and Oct. 13 of 2000 when the company tried to correct months of deliberate mispricing.
The agency also alleged that Nasgovitz and others failed to disclose significant facts concerning investment risk and the bonds' credit quality in the sale of shares in the two high-yield bond funds.
"The fraud in this case touched all levels of the operations of these mutual funds and two areas critical to investor confidence, disclosure and pricing," said Mary Keefe, regional director in the SEC's Chicago office.
Settlement split
As state and federal regulators continued to move to clean up the mutual fund industry, there were reports of another rift between New York Attorney General Eliot Spitzer and the SEC. This time the fight is over a possible settlement with mutual fund giant Alliance Capital Management.
The Wall Street Journal reported Thursday that, as part of a proposed deal with Spitzer's office, Alliance has offered to cut the annual fees it charges investors for managing its funds.
The negotiations involve settling the separate issue of whether Alliance allowed improper trading in its funds at the expense of ordinary fund holders.
But the SEC, which also is in settlement talks with Alliance, says any change in fees should be handled through new regulatory rules, rather than through enforcement actions.
SEC Chairman William Donaldson recently blasted Spitzer's push to link lower fees with charges of improper trading, saying it is "improper to try to piggyback the fee-disclosure issue on an unrelated matter.