Tipster Set Fund Scandal Snowballing

Dozens of hedge funds were trying this strategy, and many mutual fund managers hated them because the sudden inflows and outflows increased costs and cut into profits for long-term investors. The Canary team stood out from the pack -- it earned a return of more than 25 percent in 2001, a year in which the standard stock indexes all declined.

One evening in 2002, when Harrington happened to be working late, she watched the Canary team begin to celebrate a big score. "We just picked off this fund," Harrington remembered a trader crowing as the group crowded around a computer terminal they referred to as "the box." The whole scene seemed odd to her. Same-day mutual fund trading was supposed to stop at 4 p.m. This was well into the evening. "Who are you trading with? Japan?" she asked. No one answered.

Now on the alert for odd behavior, Harrington noticed that the Canary traders routinely wrote order tickets in the hours between 4 p.m. and 8 p.m. She also began to wonder if the trading was connected to a call Stern had asked her to make to Goldman earlier that year. Eddie wanted to make frequent trades in and out of Goldman's mutual funds, but the honchos there had turned him down. Stern had hoped Harrington could find him another way in.

No dice. "Noreen, you can't do that; it's illegal," Harrington's pals at Goldman had said. "We can't have that kind of turnover in our funds."

She tried to sleuth discreetly. Fellow employee James Nesfield, a former trader now in North Carolina, told her his job was to find "capacity," funds where Stern's team could make their enormous investments and then pull out within days without having to pay a fee, usually known as a redemption charge.

That kind of cat-and-mouse game sounded wrong, so Harrington went directly to Eddie Stern. "Is this legal?" she asked. A lithe and smooth-talking Haverford graduate who could ooze charm when he wanted to, Eddie sidestepped the question. "If the regulators ever look at it, they'll want the mutual funds, not me," he assured Harrington.

By Labor Day 2002, Harrington had left the Stern family business, but she initially kept quiet. She believed Stern's trading was an isolated problem, and she wasn't inclined to jeopardize her own future on Wall Street by rocking the boat. But her next job, with a private investment boutique, brought her into contact with lots of hedge fund managers who openly engaged in market timing. When she asked them about after-hours trading, they tended to tiptoe around the subject rather than reject the idea outright.

She also began to focus on the harm Stern was doing. In April 2003, Harrington's sister, Mary Ellen Corrigan, was so appalled by the shrinking value of her 401(k) retirement account that she sent Noreen a copy of her statement, accompanied by a bitter joke: "I guess I'll have to work forever." On the statement, Harrington recognized the names of several fund companies that she knew had been granting Stern special trading privileges.

She realized with a start that she had been working for a reverse Robin Hood. "Money isn't created," she observed. "It's taken from one person to another. [Stern was making money off] people who had no money."

'A Man on a Mission'

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By late May 2003, Harrington was convinced she had to do something. "I'm a senior person in the industry. We're supposed to police ourselves. I don't want people to think we're all crooks," she remembered thinking. But where should she go? For the past few months, the papers had been full of articles about Spitzer and his ambitious "global settlement" that had reformed Wall Street stock research. "He had a profile in the paper that was clear; he was a man on a mission," she said.

The more one of Spitzer's lawyers, David Brown, thought about Harrington's story, the odder it seemed. Why would fund companies allow Stern the privileges Harrington had described? Market timing increased expenses, cutting into returns for long-term investors. Harrington had a ready answer for the fund managers' duplicity: "For the fees, of course," she explained.

Fund companies made money by charging customers a management fee based on a percentage of the assets they invested, and as a fund company's funds grew, so did its income. Market timers, in exchange for permission to jump in and out of individual funds, would usually agree to park a certain amount of cash with the fund company overall, generating a steady stream of fees.