Alliance, Regulators Reach Settlement

The settlement comes after the US Securities and Exchange Commission (SEC) and New York Attorney General Eliot Spitzer found thatAlliance Capital entered into arrangements permitting market timing – rapid-fire trading in and out of mutual fund share to take advantage of pricing inefficiencies – in certain of its funds. In exchange, Alliance Capital solicited from these market timers long-term investments, so-called “sticky assets” or “legit assets,” in its hedge funds and mutual funds, according to a news releases released by the two regulatory bodies.

These activities in turn exposed the firm’s mutual funds to what it recognized as potential adverse effects of market timers, the SEC said.   Thus, Alliance Capital , one of the nation’s largest publicly traded money managers with roughly $456 billion under management,breached its fiduciary duty to those funds and misled those who invested in them, the SEC said.

Per terms of the settlement, Alliance Capital will set aside $250 million in a separate fund to compensate mutual fund investors harmed by the improper market-timing activity.   The restitution fund, which was agreed on by the SEC and Spitzer’s office, will include $150 million as disgorgement of profits and a $100 million penalty.

“Alliance Capital violated the first rule for investment advisers – to protect the interests of the client. A violation of this fundamental trust warrants a most severe sanction, and the SEC’s order reflects that. The size of the payment – the largest ever by a mutual fund adviser – also ensures full compensation to investors injured by these timing arrangements,” Stephen Cutler, Director of the SEC Division of Enforcement said in a statement.

Spitzer Agreement

The settlement with Spitzer’s office also includes a weighted average reduction in fees of 20% on Alliance Capital’s US long-term, open-end retail funds, which will start in January and continue for at least five years.   “This settlement will fundamentally alter the way this company is run,” Spitzer said in a statement. “Instead of favoring managers, the company will now focus on the interests of investors by eliminating harmful market timing and reducing fees for all shareholders.”

Spitzer’s inclusion of a rate cut was a sore spot between the two regulatory bodies.   The SEC, whose settlement contains no provisions for fee cuts, maintains fees are unrelated to trading abuses, while Spitzer has made winning fee cuts a goal.

“This is a case about illegal market timing, not fees,” the SEC said in a statement. “Therefore, we see no legitimate basis for the commission to act as a ‘rate-setter.'”

Other provisions of the settlement call for at least three quarters of the directors on its funds’ boards to be independent, and its directors will be able to hire staff to assist them in doing their jobs.   Both of these provisions were inserted in an effort to improve governance.   

Ultimately, the settlement comes at a steep price.   In connection with the payment to be made through a restitution fund, Alliance Capital said it expects to take a $140 million pretax charge against fourth-quarter profits.  As a result of this and a third-quarter charge, Alliance said it and Alliance Holding expect not to make a distribution payment to unit holders for the fourth quarter.   Distributions are expected to resume for the first quarter of 2004, with the payout policy returning to traditional levels for the second quarter of 2004, Alliance said.

In addition, the 20% fee reduction is valued at $70 million per year.   Thus when combined with the $250 million restitution payment, the total value of the settlement is approximately $600 million.