Ripples of Canary Fund Trading Probes Continue to Spread

September 19, 2003 ( - The ripple effect of a spreading investigation into mutual and hedge fund trading improprieties continues to wash through the financial services industry with three mutual fund companies launching their own in-house probes.

Janus Capital Group and Strong Capital Management are hiring outside investigators to review their trading practices in light of allegations that hedge fund Canary Capital Partners had engaged in illegal trading practices with several mutual fund companies, including making deals after the market had closed for the day, according to news reports.  Prudential Financial said it, too, had initiated an internal review. Canary has already agreed to pay $40 million to settle the allegations and word surfaced Friday that a second hedge fund may also have been snared in the investigation.

In the case of the Denver-based Janus, which recently got slammed by mutual fund research firm Morningstar for its role in the scandal (See  Morningstar Cautions Investors in Wake of Canary Scandal ),    spokeswoman Shelley Peterson said Janus was “in the process” of hiring an independent auditor to conduct a review of its trading practices, one of the steps it said it would take in light of the probes.

New York State Attorney General Eliot Spitzer said Canary obtained special trading opportunities with Strong, Bank of America’s Nations Funds, Banc One and Janus by promising to take substantial positions in various funds managed by these institutions. Spitzer, the US Securities and Exchange Commission, and state regulators in at least two states are all investigating (See  Spitzer Fund Abuse Probe Pumps Out More Subpoenas ). 

Two types of trading violations have been alleged: Late trading, or buying mutual-fund shares after the market close at that day’s closing price; and timing, which involves taking advantage of market-moving events after the close of the market, when the funds’ daily price is set based on the net-asset value of the portfolio. Spitzer also accused Canary of frequent in-and-out “timing trades” at the mutual funds, which, for example, take advantage of differences between closing prices of stocks overseas and the mutual fund’s later closing value. While this activity isn’t against the law, most mutual-fund companies prohibit it as costly to other fund investors.

Meanwhile, Colorado Securities Commission Fred Joseph told Reuters that he would be meeting with Janus officials to find out more exactly what steps they plan to take in light of the probes. Janus has said it will correct any problems and would reimburse shareholders if an auditor determines they suffered losses because of the firm’s trading practices.

Strong Founder: Wants “Objective Review”

Separately, Strong founder and chairman Richard Strong told a dinner audience in Milwaukee that his firm has likewise kicked off its own review of its trading activities. “We have hired outside professionals to conduct our own comprehensive internal review,” Richard Strong said Thursday, according to the news reports. “The evaluation is not yet complete — we look forward to an objective review of the facts.”

Spitzer has alleged that Strong allowed Canary to time the market by actively trading five Strong funds. Spitzer’s complaint also accuses Strong of giving lists of the securities those five funds owned more often to Canary than to other shareholders. In exchange, Spitzer says, Strong received commitments from Canary to keep as much as $18 million in a Strong brokerage account to trade the funds, and to keep another, unspecified amount of “substantial additional assets” in Strong hedge funds.

Eight state court lawsuits have been filed in Wisconsin since Spitzer made the allegations, according to the news reports.

Spitzer, Feds Demand Pru Data

Finally, both Spitzer and federal regulators appear to be taking a closer look at fund trading practices at Prudential Financial with both asking the firm for information.

The Newark, New Jersey-based company said it received formal information requests from the US Securities and Exchange Commission, the NASD and Spitzer. It said it is cooperating with all inquiries and conducting an internal review.  Spokesman Bob DeFillippo declined to discuss the scope or expected duration of the internal review, according to the news reports. The company announced the data requests in a securities filing.

Two weeks ago, Prudential in another securities filing said it was subpoenaed by Massachusetts regulators seeking information about “market timing” in funds in its Prudential Securities’ Boston office.

Also, Bank of America has fired several employees involved with its fund business, including Nations Funds head Robert Gordon, who were named in the Spitzer complaint. On Tuesday, Theodore Sihpol, who was a broker for Bank of America until he was fired last week, was charged by Spitzer with grand larceny and securities fraud.

A Good ‘Samaritan ?’

Word also surfaced late Friday that the Illinois Secretary of State’s office was now looking into Samaritan Asset Management Services,  a hedge fund founded by Edward Owens, a philanthropist to Christian charities. The SEC is also probing Samaritan, according to a Reuters report.  Samaritan, based in Barrington, Illinois, was not charged in Spitzer’s probe.

However, investigators say that Samaritan was the only investment fund other than Canary Capital, and one other Canary-related fund, that received special trading privileges from Security Trust Corp. (STC), a Phoenix-based trustee/custodian. STC has already stated publicly that its in-house investigation found that no other customers were harmed and that Canary had assured it that the Canary trades were properly received before market close (See STC: Canary Trades Didn’t Harm Other Clients ).