Money management company Pilgrim Baxter & Associates agreed Monday to pay $90 million in fines and restitution, to reduce fees $10 million and to help federal and state regulators build a fraud case against the firm's two founders, who are charged with helping associates profit from short-term trading at the expense of firm customers.
The Wayne, Pa.-based firm cut deals with both the Securities and Exchange Commission and New York Attorney General Eliot L. Spitzer to settle investigations into allegations that the firm allowed a few customers with connections to founders Harold J. Baxter and Gary L. Pilgrim to engage in market timing, while telling other customers the practice was barred. Since September, more than a dozen fund companies have paid fines to end investigations into market timing, a kind of predatory rapid trading that seeks to exploit gaps between a mutual fund's share price and the value of its underlying assets.
The firm agreed to pay $50 million in civil penalties and give back $40 million it made in management fees from allowing the market timing. All the money will go into an SEC-administered fund for distribution to investors in the firm's PBHG funds. Under its deal with Spitzer, Pilgrim Baxter also agreed to cut management fees it charges PBHG customers by $10 million over five years.
The SEC and Spitzer are still pressing civil fraud charges against both Baxter and Pilgrim, who were chief executive and president, respectively, until they were ousted by the firm in November. The regulators alleged in complaints filed last fall that Pilgrim earned $4 million in personal profit in 2000 and 2001 from investing in Appalachian Trails, a hedge fund that made more than 110 short-term trades in the PBHG mutual funds.
The regulators also alleged that Baxter not only approved the arrangement with Pilgrim's hedge fund but also shared inside information about the funds' holdings with a friend who owned the Wall Street Discount Corp. brokerage. The broker then passed information on to his clients and helped them profit from short-term trades in the PBHG funds, the filings said. When Pilgrim Baxter barred most short-term traders from its funds in July 2001, both Appalachian and the clients of Wall Street Discount were exempted.
"This has the potential to become one of the largest insider trading cases in history depending on the evidence," said Ari Gabinet, administrator of the SEC's Philadelphia office, which brought the case. "The timers were raking in the dough at a time when the mutual funds were tanking."
Gabinet said the portfolio information would have made it easier for the market timers to profit from market fluctuations and allowed them to profit even in down markets by buying "swaps," a financial instrument through which an investor can bet that a portfolio of specific stocks will fall.
A spokeswoman for Baxter declined to comment. Pilgrim's attorney did not return phone calls seeking comment.
"These agreements serve to protect shareholder value and reach a resolution in the best interests of the shareholders of the PBHG Funds," chief executive David J. Bullock, who joined the firm in July 2003, said in a statement. "Together with the significant reforms we have already made to the company's policies and practices, the provisions of these settlements bring long-term benefits to our fund shareholders."
PBHG prospered in the go-go 1990s by betting heavily on technology stocks. But investors and the fund company were hit hard by the bursting of the high-tech bubble. Regulators say the funds' abysmal returns were further depressed by Pilgrim Baxter's decision to welcome large amounts of market-timing money into its relatively small funds. At the peak, timers held $466 million, or 14 percent, of the assets in the flagship PBHG Growth Fund, with the average short-term investment lasting less than three days, the regulators said. The volume forced PBHG's portfolio managers to keep large amounts of money in cash to pay investors cashing in their shares, cutting into overall returns by reducing the amount invested.
Pilgrim Baxter had $5.2 billion in assets under management at the end of the first quarter, down from $7.4 billion when the scandal broke. The firm is owned by London-based Old Mutual PLC.
The firm "has agreed to a fair settlement and promised continuing cooperation in the investigation of misconduct by its founders," Spitzer said in a written statement. "This agreement helps investors . . . and allows the company to begin the process of restoring its integrity."