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2 Quit, 1 Fired At Federated

Nov 27, 2003 | Pittsburgh Thomas Olson

Two mutual fund salesmen involved in market-timing trades resigned from Federated Investors Inc., which fired a third worker for deleting e-mails related to the Pittsburgh firm trading fund shares after hours, an illegal practice that's scandalized the $7 trillion industry.

The firm said late Tuesday that Texas-based hedge fund Veras Partners, for instance, placed 15 orders after 4 p.m. which were executed by Federated "employees who did not have a sufficient understanding" of rules governing after-hours trading. Fred Alger & Co.'s chief mutual fund officer pleaded guilty earlier this month to covering up fund trades with Veras. "We're concerned about the lax oversight that was going on," said Kerry O'Boyle, a mutual fund analyst at Morningstar Inc., fund-rating firm based in Chicago.

"I find it hard to believe these individuals were just out there on their own without anybody else at Federated knowing what they were up to," said O'Boyle, who since Nov. 15 has advised investors not to buy Federated mutual funds.

Trading mutual funds after 4 p.m. is illegal because it unfairly exploits relevant news released after U.S. exchanges close. Frequent trading, or "market timing," hurts long-term holders because multiple transaction costs cut into investment gains.

Federated declined to identify any of the three individuals on Wednesday or whether they worked at the headquarters Downtown.

A statement from CEO J. Christopher Donahue said "one mid-level Federated officer came forward" and confessed to deleting "several e-mails" relevant to investigators, and was fired. The two sales reps resigned after confirming they arranged with hedge funds, including Canary Capital Partners, to transact market-timing trades.

Canary Capital and its managers settled an unrelated case with New York authorities in September, paying $30 million in restitution for profiting from illegal trading.

"Senior executives had no knowledge of late trading," said Federated spokesman J.T. Tuskan.

The firm was subpoenaed in early September by New York Attorney General Eliot Spitzer regarding its fund trading practices. Federated received similar subpoenas from the Securities and Exchange Commission and the National Association of Securities Dealers.

To do its own investigation, Federated hired the Downtown law firm Reed Smith in September. It continues to review "tens of thousands of documents, files and e-mails" related to funds trades since January 2000.

Of roughly 38,000 orders Federated took during those 45 months, 5,000 involved orders taken before 4 p.m. and legitimately processed after 4 p.m. But another 100 orders were illegally taken and processed after 4 p.m., Tuskan said.

"We will not rest until we complete our review and address the issues involved," Donahue's statement said. The internal probe won't be done "for a number of weeks," Tuskan said.

Its initial findings turned up no formal agreements by Federated to accept mutual fund orders after 4 p.m. from investors, including hedge funds, the firm said.

Federated employs roughly 1,700 people, the vast majority of whom work Downtown. Federated, the nation's fifth-largest mutual fund firm, manages about $201 billion in investment assets, mostly held in 135 mutual funds.

The firm's disclosure comes amidst news that federal regulators closed a major fund servicing company in Phoenix late Tuesday for its role in market timing of mutual fund transactions.

Security Trust Co., which administers about $13.4 billion in retirement assets, was ordered by the U.S. Comptroller of the Currency to dissolve by March 31. In addition, New York prosecutors filed criminal charges, and the Securities and Exchange Commission filed civil charges, against three former executives.

Federated is the subject of at least five shareholder class-action lawsuits surrounding the fund-trading.

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