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Prudential Did Staggering Number of Mutual Fund Trades for Hedge Funds

Dec 12, 2003 |

Prudential Securities Inc. persisted in executing market timing and after-hours trades by offshore hedge funds on a large scale despite numerous warnings from mutual funds, according to a Dec. 11 complaint against the broker-dealer by Massachusetts Secretary of the Commonwealth William Galvin.

Senior Prudential executives knew of and encouraged the practice, allegedly detrimental to the interests of long-term mutual fund investors, as they were “reluctant to pass up the substantial profits generated by courting these multi-million dollar hedge fund accounts,†says the complaint.

Michael Rice, former president of the private client group, was among those complicit in this scheme, it claims. A group led by Martin Druffner initiated the trades in question from the Boston office Previous HedgeWorld Story.

When a mutual fund demanded that the problem trading in its shares be stopped, “Prudential undertook only the minimum corrective action necessary to maintain a business relationship with the mutual fund,†the complaint states.

Galvin’s investigation found that Prudential’s mutual fund exchange desk entered at least 1,212 transactions for three brokers in the Druffner group between Jan. 30, 2001 and Aug. 23, 2003, representing US$162.4 million. Branch managers allowed numerous trades by hedge funds at the same day NAV after trading was supposedly closed at 4 p.m.

A Flood

Prudential brokers working with hedge funds routinely placed a flood of trades between 3:30 and 4 p.m., according to the complaint. “The trading volume was so excessive that certain employees were instructed to only work on putting these trades through even if it meant neglecting retail customer orders.â€

Prudential’s favored hedge fund customers included Chronos Asset Management, a fund seeded by the Canadian Imperial Bank of Commerce, as well as Head Start Advisors, Pentagon Capital Management PLC and Ritchie Capital Management LLC.

No charges have been filed against hedge funds in relation to the Prudential investigation. The U.S. attorney in Boston, however, may be looking into the matter, and further legal action is possible.

Galvin’s complaint involves non-proprietary mutual funds that the broker-dealer handled. In its own funds, Prudential apparently took steps to avoid the excessive turnover associated with market timing.

Massachusetts wants it to pay a fine that is yet to be determined and compensate mutual fund shareholders for losses caused by the rapid trading and late day pricing. The amount of such losses is not easy to establish, however.

Academic studies have estimated total loss for mutual fund customers from all such trades on the basis of certain assumptions. But tracing the effect of trades executed by a specific broker is more difficult. The effects are indirect and would require estimating changes in transaction costs as well as any potential difficulty caused to the mutual fund’s investment program that might have reduced returns.

Prudential Securities Inc. merged with Wachovia Securities LLC earlier this year.

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