TheStreet.com reported that Paul Flynn was arrested at his home in Larchmont, New York, by authorities attached to the New York attorney general, Eliot Spitzer, for violations under the Martin Act, a 1921 state law governing securities sales. TheStreet.com sources said Flynn was scheduled to be arraigned later Tuesday in a New York State court. The US Securities and Exchange Commission (SEC) also plans to file civil securities fraud charges against Flynn, sources said.
Regulators believe Flynn’s group helped finance the hedge fund clients of Oppenheimer & Co. broker Michael Sassano, thought by regulators and securities industry sources to be a central figure in the probe of mutual fund market timing, TheStreet.com reported. Sassano was a top-performing broker at CIBC before it sold the Oppenheimer division in early 2002.
In a move that could be related to the CIBC investigation, a source said Massachusetts regulators two weeks ago served Sassano with a subpoena in order to force him to testify about the market-timing scandal. Sassano was previously named but not charged in a Massachusetts action against several Prudential Securities brokers and has ties to numerous players in the burgeoning scandal (See Prudential Securities Charged with Late Trading ).
Flynn’s arrest is a significant turn in the ongoing fund trading investigation because CIBC was allegedly the biggest financier of hedge funds engaged in market timing and late trading (See CIBC Could Face US Suits Over Fund Trades ). The bank is believed to be in advanced settlement talks with Spitzer’s offices and the SEC.
Total Return Swaps
Sources previously told TheStreet.com that Flynn’s group at CIBC specialized in credit derivatives, most commonly “total return swaps,” an often-used hedge fund leverage tool. Hedge funds favor the vehicle, in which the economic performance of a specified asset is exchanged for cash payments pegged to a benchmark, because they act like loans with a more favorable tax treatment. The group also provided standard margin loans. TheStreet.com said its sources indicated that the total return swaps enabled hedge funds to invest four or five times as much money as they normally would have been allowed.
Regulators believe the $1 billion in CIBC financing enabled a select group of hedge funds to make big profits from market-timing mutual fund shares and possibly other improper trading activities. CIBC, meanwhile, was able to book highly profitable loans to clients whose risk was limited by the relatively sure-thing nature of their objectionable trading strategies.
Sources familiar with the investigation by the SEC and Spitzer’s office said much of the $1 billion went to bankroll the hedge fund clients of Sassano, the Oppenheimer & Co. stockbroker who turned mutual fund market-timing into a $10-million-a-year personal gold mine.
At this time, regulators and prosecutors only plan to identify a handful of the hedge funds that received financing through CIBC. That list includes Canary Capital Partners, Samaritan Asset Management and Chronos Asset Management. Both Chronos and Samaritan are former hedge fund customers of Sassano.
Sources said regulators also may reveal a relationship between CIBC’s financing arm and Security Trust, the Phoenix-based trust bank that regulators are shutting down because of its involvement in the mutual fund trading scandal (See Report: Spitzer Grand Jury Continues STC Probe ). Security Trust enabled Canary and other hedge funds to engage in late trading and market timing, authorities said.
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