Hedge fund to pay $40M to settle illegal trading case

By Meg Richards
Associated Press

NEW YORK — A hedge fund agreed to pay $40 million to settle charges by New York's attorney general that it engaged in illegal trading with several large mutual fund companies, including Janus and Strong, that potentially cost small investors billions of dollars.

Canary Capital Partners LLC, a multimillion-dollar hedge fund, and its managers agreed to pay $30 million in restitution of illegal profits generated from unlawful trading, plus a $10 million penalty, Attorney General Eliot Spitzer said yesterday. The hedge fund's officials also agreed to cooperate with an ongoing investigation of the mutual fund industry, he said.

Canary allegedly obtained special trading opportunities with leading mutual fund families — including Bank of America's Nations Funds, Banc One, Janus and Strong — by promising to make substantial investments in various funds they managed, Spitzer said.

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

"The fees that were garnered by the mutual funds in return for this blatantly illegal behavior were very substantial," Spitzer said at a news conference where he displayed e-mails and documents in which the firms discussed the schemes.

For example, Banc of America documents showed the firm estimated it made $2.25 million per year from such relationships, he said.

"The full extent of this complicated fraud is not yet known," Spitzer said in a statement. "But one thing is clear: The mutual fund industry operates on a double standard. Certain companies and individuals have been given the opportunity to manipulate the system."

Canary did not admit or deny wrongdoing. A statement from the firm said it agreed to the settlement "to avoid protracted and complex litigation." In addition, fund manager Edward J. Stern has agreed not to trade in mutual funds or manage public investment funds for 10 years.

Calls to the mutual funds involved were not immediately returned.

Spitzer said his office would act to ensure illegally obtained profits are returned to investors. "The victims here were 'mom and pop' investors ... not the sophisticated investors," he said.

SEC Chairman William Donaldson said in a statement: "The conduct alleged in the complaint is reprehensible, and there is no place for it in our markets. 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."

Spitzer's investigation of mutual fund trading practices began this year, focusing largely on late trading and market timing.

Late trading involves buying mutual fund shares at the 4 p.m. price after the market closes — equivalent to "betting on a horse race

after the horses have crossed the finish line," Spitzer said. The practice is prohibited by New York's Martin Act and Securities and Exchange Commission regulations.

Market timing is an investment technique of short-term, "in and out" trading of mutual fund shares, which has a detrimental effect on the long-term shareholders for whom mutual funds are designed.