SEC, Spitzer File Charges Against Pilgrim Baxter FoundersNov 20, 2003 | The Wall Street Journal The Securities and Exchange Commission and the New York state Attorney General's office brought fraud charges Thursday against the co-founders of Pilgrim Baxter & Associates for their alleged involvement in "market timing" of the firm's mutual funds.
Gary L. Pilgrim and Harold J. Baxter were also charged with breaching their fiduciary duty to the firm's clients in connection with the market timing, the SEC said.
"Gary Pilgrim and Harold Baxter failed to uphold their end of the bargain with the mutual-fund investors who entrusted them with their hard-earned savings," said the SEC's enforcement director Stephen Cutler.
According to the agency, Mr. Pilgrim's market timing activities resulted in about $3.9 million in profit in 2000 and 2001.
Mr. Pilgrim stepped down from his position as president and a director of the firm and Mr. Baxter resigned as chief executive and chairman on Nov. 13.
Pilgrim Baxter & Associates, which is owned by insurer Old Mutual PLC of London, said in a Nov. 13 statement that an internal review found Mr. Pilgrim allowed an investment vehicle he controlled to rapidly trade shares in PBHG Funds between March 2000 and December 2001. The firm said Mr. Baxter wasn't an investor in Mr. Pilgrim's investment fund, but had knowledge of the arrangement.
In its complaint, the SEC said the defendants allowed a hedge fund in which Mr. Pilgrim and his wife had a substantial interest to engage in market timing of a growth fund that Mr. Pilgrim managed. The hedge fund is known as Appalachian Trails, the SEC said.
As for Mr. Baxter, he knew about Mr. Pilgrim's activities and, in addition, provided nonpublic information about the PBHG fund to a close unnamed friend in the brokerage business. The SEC did say in the complaint that Mr. Baxter's friend was the president of a firm called Wall Street Discount Corporation.
Mr. Baxter's friend then allegedly passed the PBHG information on to his customers, who then used it to market time PBHG funds and to exercise hedging strategies through other financial institutions.
Notwithstanding certain published limitations in trading, Appalachian Trails and Wall Street Discount, along with at least two dozen others, are alleged to have engaged in extensive trades in and out of the PBHG funds with the defendants' knowledge and consent, the SEC contends. The market timing peaked with assets of close to $600 million and continued into the summer of 2001, the SEC added.
Pilgrim Baxter had $7.4 billion in assets under management as of Sept. 30.
Neither Mr. Pilgrim nor Mr. Baxter disclosed to their firm's board or fund shareholders that Mr. Pilgrim had an extensive financial interest in Appalachian and that Appalachian had been permitted to implement its market timing in PBHG funds, the SEC said.
In total, in 2000 and 2001, Appalachian allegedly profited by more than $13 million from its trading, $3.9 million of which was Mr. Pilgrim's share.
The SEC is seeking an order permanently barring Mr. Pilgrim and Mr. Baxter from serving in certain positions with an investment company and the return of any ill-gotten gains plus interest and other fines.
Meanwhile, New York Attorney General Eliot Spitzer is seeking fines, restitution and the return of mutual fund fees to the firm's customers.
New York state investigators have also been scrutinizing trading in PBHG funds by another hedge fund. Canary Capital Partners LLC, which has been at the center of Mr. Spitzer's investigation into mutual-fund share-trading practices that began in the summer, say people familiar with the matter. Several weeks ago, Mr. Spitzer's office advised Pilgrim Baxter that it was likely to file charges related to Mr. Pilgrim's investments in the other hedge fund, these people said.
Thursday, a spokesman for Mr. Spitzer said Pilgrim Baxter was attempting to pre-empt possible charges related to the timing trades, and that such charges could be filed as early as next week. Mr. Spitzer criticized the timing activity disclosed by Pilgrim, saying that it was "one more example of a complete breach of fiduciary duty by the most senior executives in a mutual fund," and that " this behavior drives home once again the arrogance of the industry and the failure of this industry to appreciate its fiduciary duty."