Mutuals Timing Case Shows It's Not All Mutual

By Ellen Simon
Associated Press
Sunday, July 16, 2006

Martha Stewart complained that she was almost trampled by the scrum of reporters at her trial on charges she lied about a stock sale. Stephen J. Treadway's trial, in the same Manhattan federal court, was considerably quieter, although the civil charges against Treadway were of far greater importance to average investors.

Treadway, former chairman of the board of trustees of the Pimco Advisors equity funds, was the defendant in the first case on timing mutual funds to go to trial. On June 30, a jury found him liable for defrauding Pimco equity mutual fund investors through a market-timing arrangement with hedge fund Canary Capital Partners LLC. Treadway faces possible civil penalties and other sanctions.

The jury found that Treadway allowed a single wealthy investor to engage in a practice closed to everyone else, a practice that ate away at other investors' returns. It was only the latest chapter in the mutual fund market-timing scandal, which first became public in 2003. Litigation and settlements continue, a reminder to investors that the mutual fund industry does not always act in the best interests of the little guy.

"When you invest in a mutual fund, you are trusting that every investor, big or small, rich or poor, is going to be treated the same. That's not what happened at the Pimco equity fund," said Randall R. Lee, regional director of the Securities and Exchange Commission's Los Angeles office. Treadway's attorney did not return calls requesting comment.

In the Pimco equity case, hedge fund Canary agreed to make $25 million in long-term investments in a Pimco equity fund in exchange for secret privileges that let it market-time Pimco equity funds, rapidly buying and selling the funds to take advantage of differences in the daily closings of stock markets around the globe, according to the SEC. While market-timing is not in itself illegal, the fund's prospectus expressly prohibited such trading, and the company sent hundreds of letters to other rapid traders telling them to stop.

As with other market-timing cases, only the privileged were allowed to skip in and out of funds repeatedly. Canary, for instance, engaged in about 108 buy-and-sell transactions that totaled more than $4 billion in Pimco equity funds, according to the SEC. Such trading can increase funds' transaction costs and force the funds to keep more cash, lowering their returns, the SEC said.

Pimco stock funds are now part of the Allianz fund family. Pimco's bond-fund group, Pacific Investment Management Co., was never accused of wrongdoing.

Pimco stock funds have plenty of market-timing company. Since the scandal began, companies have paid nearly $2.8 billion in civil penalties and disgorgements, according to the SEC. Some of the biggest names in the industry paid big: Janus Capital Management LLC paid $100 million; Invesco Funds Group Inc., AIM Advisors Inc. and AIM Distributors together paid $326.1 million; and Alliance Capital Management LP paid $250 million. Pimco stock funds and Allianz have not paid any penalties, although three related companies paid $50 million in 2004 to settle charges that they defrauded investors.

"The mutual fund industry had coasted on its reputation as the clean corner of the securities markets for years," said Barbara Roper, director of investor protection at the Consumer Federation of America. "The trading scandals were sort of a wake-up call that maybe everything wasn't as ethical and aboveboard as lots of people had thought it was."

Publicity about the scandal crested in 2004, but enforcement continues. In June, Alger Management and its parent, Alger Inc., agreed to a $40 million settlement with the SEC and the New York state attorney general's office. Alger, which has not admitted or denied liability, also agreed to remedial measures including a reduction in management fees of $1 million a year for five years. The settlement, which has not been finalized, relates to both market-timing and another practice known as late trading, in which privileged investors were allowed to lock in a 4 p.m. price on a mutual fund after the market's close.

One of the rule changes proposed after the scandal, a requirement that mutual funds' board chairmen be independent, has been knocking around the courts for years. After the latest ruling, the SEC put the proposal up for comment; the comment period closes Aug. 21.

Treadway was both chairman and chief executive of Pimco Advisors Fund Management LLC and Pimco Advisors Distributors LLC. But the malfeasance at Pimco equity funds was so widespread, it's arguable that an independent chairman might not have been able to protect investors. The funds' adviser, sub-adviser, distributor and the former chief executive of a sub-adviser have all settled civil charges related to the timing.

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