Gary L. Pilgrim and Harold J. Baxter, founders of a tech-based mutual fund that blazed and then fizzled in the 1990s, agreed yesterday to pay $160 million to settle charges that Pilgrim took advantage of trading opportunities and Baxter shared inside information at the expense of investors.
The payments, which are in addition to $100 million in fines, restitution and lower fees agreed to by the company, are the largest ever by individuals in the mutual fund scandal. Both of the former executives also are barred for life from the industry.
New York state Attorney General Eliot L. Spitzer and the Securities and Exchange Commission had alleged that Pilgrim, the former president of the company originally known as Pilgrim Baxter & Associates Ltd., and Baxter, the former chief executive, secretly allowed associates to engage in a type of predatory short-term trading known as market timing, which was explicitly prohibited by the firm's PBGH funds.
"We think the misconduct here was egregious and it was a fundamental betrayal," said SEC Enforcement Division chief Stephen M. Cutler. "We wanted a penalty that obviously would sting and send a strong message."
As is customary in such settlements, neither man admitted or denied wrongdoing. Each will pay $60 million in restitution plus $20 million in fines. A spokeswoman for the two men, Joele Frank, said, "They decided that the best course of action was to put this behind them."
"We're pleased that the settlements that have been reached with Gary Pilgrim and Harold Baxter call for all payments to be distributed to affected shareholders of the PBHG Funds," David J. Bullock, chief executive of Liberty Ridge Capital Inc., formerly Pilgrim Baxter & Associates, said in a written statement. The Wayne, Pa.-based firm forced out Pilgrim and Baxter last November.
Pilgrim, 64, earned nearly $4 million in personal profit in 2000 and 2001 by investing in a hedge fund that was allowed to make more than 100 short-term trades in the funds, according to the complaints filed last November. The complaints also said Baxter, 58, had approved the arrangement with Pilgrim's hedge fund and shared information about the mutual funds' portfolio holdings with a friend who was a broker. The broker passed the data onto several hedge fund clients who were also permitted to engage in short-term trading in PBGH funds. Having portfolio information makes it easier for short-term traders to determine when fund prices are not up to date and profit from the discrepancy.
"Not only is [Baxter] allowing these hedge funds to time, but he's giving them further information to make their timing more effective," said Assistant New York Attorney General Charles T. Caliendo, who handled the case for Spitzer. "That injures shareholders. It's appalling."
The penalties appear to be the largest paid by individuals since securities fraud cases against Michael R. Milken and Ivan F. Boesky in the 1980s. The previous record in the mutual fund scandal was Richard S. Strong, who agreed in May to pay $60 million and apologized for improper personal trading in the Strong funds he supervised.
Estimates of the loss to shareholders in the Pilgrim Baxter case ranged from more than $200 million to nearly $1 billion, depending on the method of calculation. At their peak, the PBGH funds managed $18 billion, but the funds averaged less than $10 billion in the period of intense market timing.
"The dilution to the shareholders was an astonishing amount in comparison to the size of the funds," said Ari Gabinet, who heads the SEC's Philadelphia office, which brought the case.
Under New York's Martin Act, Pilgrim and Baxter could apply for a reinstatement to the financial services industry in five years but are not guaranteed success, Spitzer's office said. The settlement also limits both men's personal trading. If they invest in mutual funds for themselves or family members, they must hold the shares for at least a year.
Pilgrim and Baxter were among the largest unresolved cases stemming from Spitzer's 14-month-old investigation of improper short-term trading in the $7.4 trillion mutual fund industry. His office calculates that the industry has given up $2.9 billion in fines, restitution and fee reductions. The SEC is continuing to investigate other mutual fund abuses, including undisclosed payments to brokers who recommended particular funds.
The case was delayed while Spitzer's office considered whether to bring criminal charges against Pilgrim and Baxter, sources familiar with the investigation said. The office, which made a similar decision in Strong's case, gave the two executives credit for ceasing their timing activities more than a year before Spitzer brought his first case in the area. The attorney general's office also concluded that the conduct was not clearly criminal.
Still, the size of the settlement and the relative speed -- compared with previous financial scandals -- will go a long way toward deterring similar behavior, said University of Texas law professor Henry T. C. Hu. "There are enough zeros here that even the very rich people will think twice," he said.
The Pilgrim and Baxter settlements come at a time when there is growing debate on the SEC about the wisdom of imposing large fines on companies. Two Republican members have begun to argue that big payments unfairly penalize shareholders, many of whom were already victimized by the original fraud. But the Pilgrim and Baxter deals escaped that problem, legal analysts said.
"Here the fine isn't being passed on to the individual shareholders of a company who were also the victims. The payment is being made by the alleged wrongdoers," said Robert J. Giuffra Jr., a white-collar defense lawyer at Sullivan & Cromwell LLP.