Alliance Agrees to $600 Million Settlement In Improper Mutual Fund trading CaseDec 19, 2003 | AP Alliance Capital Management agreed to a $600 million penalty to resolve allegations of improper mutual fund trading, the most costly settlement to date in a scandal that has tainted the entire industry and divided regulators.
An agreement jointly negotiated by the Securities and Exchange Commission and New York Attorney General Eliot Spitzer calls for the company to pay $250 million in restitution and to take new steps to improve its corporate governance and prevent trading abuses that harm fund shareholders. The deal was announced on Thursday.
"Alliance Capital violated the first rule for investment advisers to protect the interests of the client," said Stephen M. Cutler, director of the SEC Division of Enforcement. "A violation of this fundamental trust warrants a most severe sanction, and the SEC's order reflects that."
The SEC did not participate in a separate $350 million settlement negotiated by Spitzer, which requires Alliance to reduce its fees by 20 percent and freeze them at the lower rate for at least five years, costing it $70 million annually. The SEC said it was "inappropriate" to squeeze fee concessions from the company to settle a trading abuses case a contention that prompted Spitzer to say the SEC deal "sells investors short."
Spitzer has criticized the SEC in the past, as have others, saying the agency has not been aggressive enough in curbing fund abuses and being too eager to settle cases.
Despite the disagreement among regulators, analysts said the settlement will likely affect the outcome of investigations involving dozens of other fund companies including Invesco Funds Group, Putnam Investments, Strong Investments and Prudential Securities.
They say the sheer size of the agreement and Spitzer's requirement that Alliance lower its fees suggests other companies will have to make similar deals if they want to stay out of court.
"This certainly sets a precedent. I think that was what Spitzer was trying to do. He's made it clear he wants to tackle mutual fund fees, and he has here," said Dan Culloton, a fund analyst at Morningstar Inc.
The fees investors pay for management, trading and other fund expenses vary widely. In the case of Alliance funds, Spitzer's office has said small investors paid fees two to three times as much in fees than their institutional counterparts.
Alliance, which did not admit wrongdoing as part of the deal, had previously acknowledged that shareholders had been hurt by the trading abuses. In a statement Thursday, Alliance chief executive Lewis A. Sanders said the settlement would benefit its investors and "strengthen the governance and thus the integrity of our mutual fund services."
Alliance is one of the nation's largest money managers, with $456 billion in assets under management as of Nov. 30, primarily for pension funds and other institutional customers. The company also manages mutual funds, many under the AllianceBernstein brand, and owns money manager and research firm Sanford C. Bernstein.
Regulators said Thursday that Alliance violated its fiduciary duty to investors by permitting 18 hedge fund operators and broker dealers to engage in market timing of its mutual funds, despite fund policies against the practice. In return, those clients parked millions of dollars in other Alliance mutual and hedge funds, providing additional assets and revenues for the company.
Market timing is a type of quick, in-and-out trading that is not illegal, but frequently prohibited by funds because it skims profits from long-term shareholders.
Alliance's biggest market timer, Daniel Calugar, the owner and president of Security Brokerage Inc. in Las Vegas, had as much as $220 million in timing capacity in three Alliance funds and made $64 million in profits from timing trades in the funds, even as fund shareholders lost money, the SEC said.
According to the SEC order, market timing in mutual funds at Alliance reached over $600 million at its height in 2003, with the knowledge of top executives. The order did not name the executives, but identified one as "the then president and chief operating officer of Alliance Capital, who also served as the chairman and president of the mutual funds at issue here." Last month John D. Carifa resigned from those positions.
Cutler said the investigation of Alliance and other mutual fund companies continues, though he would not say if Carifa or other Alliance executives would be charged.
In addition to the market timing abuses, Spitzer said Alliance permitted investors to be overcharged, and said the cut in fees was "merely returning to investors money that they never should have been charged in the first place."
The SEC said the case was "about illegal market timing, not fees" and any fee reduction was "better left to informed consumers, independent and vigorous mutual fund boards, and the free market."
Alliance said it expects to take a $140 million pre-tax charge against fourth-quarter earnings, in addition to a $190 million charge taken in the third quarter. Alliance and its holding company, Alliance Capital Holding, also said it would not make distributions for the fourth quarter, though some payment would resume in the first quarter before returning to normal levels in the second quarter. Alliance did not return calls seeking further clarification.