Federated Confesses 15 Late Trades

November 26, 2003 (PLANSPONSOR.com) - It was confession time for Federated Investors who admitted in an unusually detailed statement this week that it had taken late trades from a hedge-fund adviser on 15 occasions.

Federated, one of the nation’s largest fund firms with about $202 billion in assets, said its investigation into late trading is now focusing on an additional 100 orders that were “incorrectly” accepted after 4 p.m., according to a Wall Street Journal story.

In its    statement , Federated said the late trades it had already detected were placed by Veras Investment Partners, a hedge-fund adviser based in Sugarland, Texas. Federated also disclosed it had permitted an arrangement to allow Canary Capital Partners LLC, another hedge fund, to engage in market timing of the firm’s domestic stock funds. Canary was at the center of the initial investigation into improper mutual-fund-share trading disclosed by New York Attorney General Eliot Spitzer in early September (See  Spitzer Fund Abuse Probe Pumps Out More Subpoenas ).

Most of the late trading uncovered thus far by authorities has taken place with the aid of intermediaries, such as brokerage firms. However, in the case of Federated, the late trades appear to have been placed directly to the fund company without the aid of a broker. Federated says it has found that Veras made late trades – all between 4 p.m. and 5 p.m. Eastern time – by placing telephone orders directly to Federated on 15 occasions.

The company blamed its transgressions on employees who accepted the trades without a “sufficient” knowledge of late-trading regulations.

Federated also confessed it had fired an employee who had deleted e-mails relevant to the investigation into market timing and late trading at the Pittsburgh firm. The e-mails were later recovered. Two other employees who were involved in arrangements to permit market timing of Federated fund shares have resigned, the firm said.

The firm and the independent directors of Federated’s 135 mutual funds have been conducting investigations into its trading practices, including late trading and market timing. Market timing, which isn’t illegal but is discouraged by many funds’ prospectuses, involves rapidly buying and selling fund shares in order to profit from discrepancies between the fund’s share price and the values of its underlying holdings.

Late trading, however, is illegal. Normally an investor placing an order to buy or sell fund shares after 4 p.m. Eastern time receives the next day’s price. But under late trading, orders placed after 4 p.m. still get the same day’s price, which can enable that investor to react to news one trading day ahead of other investors.

Canary Trades

In the statement, Federated also provided details of market timing arrangements. According to Federated, Canary was introduced to Federated by a “national brokerage firm” client that it didn’t name. Federated said it permitted Canary to trade in six of its domestic stock funds, including Federated Kaufman Fund. As part of the arrangement, Canary made a long-term investment of $10 million in a Federated short-term bond fund.

Federated said it agreed to permit Canary to engage in timing “as long as the trading was limited in frequency and scope.” Between January 22 and July 2, 2003, Canary made 46 in-and-out trades in the Federated stock funds, the firm said.

In addition, Federated allowed two other arrangements with other outside firms to allow timing in high-yield bond funds.

Along with Federated’s statement, President Christopher Donahue said in a letter to clients that the firm is continuing to cooperate with authorities and is “committed to taking remedial actions when and as appropriate,” including compensating the funds for damages done.

Separately, Citigroup said Tuesday that the Manhattan US attorney’s office is investigating transfer-agent agreements related to its mutual-fund business. Citigroup said the agreements weren’t properly disclosed to its in-house mutual funds. In response, Citigroup said it is paying those funds $16 million, plus interest, that its asset-management arm received from the arrangement.