Strong Settles with Federal, State Regulators

May 20, 2004 ( - Strong Capital Management (SCM), its founder and other employees have reached a settlement with the U.S. Securities and Exchange Commission (SEC) and Wisconsin and New York officials to resolve allegations of unlawful trading of mutual funds.

The settlement, announced by New York Attorney General  Eliot Spitzer  and Wisconsin Attorney General  Peg Lautenschlager and separately by the  SEC , includes $140 million in disgorgement and civil penalties.    Of the $140 million in disgorgement and penalties, $80 million will be paid by SCM, and an additional $60 million will be paid personally by Richard Strong, the embattled firm’s founder and former chairman.

“The settlement we reached will protect Strong investors from overreaching by their fund managers. Shareholders have a right to expect nothing less,” Spitzer said. “This agreement is part of our ongoing effort to clean up the mutual fund industry and demand accountability from those who have been entrusted by the investing public.”

The agreement will settle charges levied against Strong Capital for entering into an express agreement with hedge fund manager Edward Stern, with Canary Capital Partners LLC, allowing Stern to market time certain Strong funds, in order to obtain non-mutual fund business from Stern and his family. The agreement enabled the Canary hedge funds to make approximately 135 round trip trades in four Strong funds, realizing gross profits of $2.7 million from December 2002 to May 2003. Under Strong Capital’s policies and procedures, other shareholders would have been ejected from the Strong funds for engaging in similar trading, according to the SEC.

The $140 million in disgorgements and civil penalties is in line with the settlements reached between regulators and other fund firms includingAlliance Capital Management, Massachusetts Financial Services Co., FleetBoston Financial, Bank of America, and Putnam Investments. Those settlements include:

  • Alliance – $150 million in disgorgements, including $100 million in civil penalties
  • Bank of America – $250 million in disgorgements and $125 million in penalties
  • MFS – $175 million in disgorgements, $50 million in civil penalties
  • FleetBoston – $70 million in disgorgements, $70 million in civil penalties
  • Putnam – $10 million disgorgement, $100 million in penalties.

The civil penalties can either sent to the U.S. Treasury to be deposited into the general fund of the U.S. government or combined with the disgorgement phase of a settlement.  Disgorgements on the other hand, essentially serve to reimburse the “victims” of the wrong—in the case of the recent spate of market-timing and late-trading settlements, “to provide remuneration for investors’ aliquot share of losses suffered,” according to the SEC’s Administrative Proceeding File documentation (See The Bottom Line: Following the Money ).

Other Settlement Terms

In addition to the monetary amount, the settlement reached between Spitzer, Lautenschlager and Strong calls for structural reforms for mutual fund fees Strong charges investors and sets new standards for board independence and accountability at the mutual fund company.   Under the settlement terms, fees to Strong shareholders will be reduced by 6% for a five-year period.   This reduction is valued at $35 million, the announcement said.

The inclusion of a rate cut in Spitzer’s and Lautenschlager’s settlement is a continued sore spot between the state and federal 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.

Even though the state and federal regulators may have diverged on fee reductions, included in the provisions of both settlement was a stipulation that settlement Richard Strong, 62, will be barred from the securities industry for his lifetime.

Strong Capital Management and its founder, Richard Strong, betrayed the mutual fund investors they were duty-bound to protect. In Richard Strong’s case, his personal trades were a betrayal of the highest order, warranting the stiffest possible civil sanctions,” said Stephen Cutler, Director of the SEC’s Division of Enforcement.

In the  complaint filed by Spitzer’s office in the announced settlement, while Strong Capital was warning investors that they could be barred from trading for market timing, Richard Strong was engaging in that practice for his own personal gain.   Trading records subpoenaed by Spitzer’s office show a five-year period ending in 2002 suggest Strong made an estimated $1.8 million in personal gain from these trades   (See  Spitzer Looking at “Strong” Arming Mutual Fund Head ).  These charges eventually led to Strong’s departure from all company posts he held.

Strong is not alone, as Anthony D’Amato, one of the Menomonee Falls, Wisconsin-based firm’s highest executives, also receives a lifetime bar, as does Thomas Hooker, formerly Strong Capital’s director of compliance.   In addition to the bans,  the SEC settlement  provides D’Amato will pay $375,000 in disgorgement and $375,000 in civil penalties and Hooker will pay a $50,000 civil penalty.

“Investors in Strong funds did not always get treated equally and fairly as they had the right to expect,” said Lautenschlager . “This settlement appropriately accounts for those inequities. The settlement also ensures worthwhile reforms, while giving the company a positive opportunity to address its future.”