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Spitzer's Moves Make a Virtue of Speed

Sep 17, 2003 | BusinessWeek

Another big scandal has hit Wall Street. Only this time, the clock seems to be ticking on a swift resolution, which could bode well for the $7 trillion mutual-fund industry. Just two weeks after New York Attorney General Eliot Spitzer filed civil charges against four mutual-fund groups, securities regulators unveiled their first criminal case on Sept. 16.

That's a breakneck pace compared to the recent scandals that rocked Corporate America starting with the demise of Enron in December, 2001, where few executives have yet to face jail time or criminal charges.

Even Spitzer's huge $1.4 billion settlement in April involving claims of rampant conflicts of interest between research and investment banking in big brokerage houses failed to bring down key players so swiftly. This time, with the stakes so high for millions of investors in mutual funds, "the wheels of justice are moving," says Don Phillips, managing director for Chicago's Morningstar. "The credibility of the fund management industry is so central to the retirement and financial planning of Americans, we need this to be a clean, well-lit playing field."

$40 MILLION SETTLEMENT. Theodore Sihpol III, 36, formerly a Bank of America broker, is the first to be charged. He faces a felony count of grand larceny in connection with the civil case first brought by Spitzer against New York hedge fund Canary Capital Partners. Canary's managing principal, Edward J. Stern, has agreed to pay $40 million $30 million as restitution to investors to settle with Spitzer, neither admitting nor denying the charges of market-timing and after-hours trading.

The charges against Sihpol are "the functional equivalent of insider trading," says George B. Newhouse Jr., partner with Thelen, Reid & Priest in Los Angeles. Larceny means essentially theft under false pretenses, with the victims being the other investors in the mutual funds, which allegedly were manipulated in a very sophisticated financial fraud, Newhouse says. In essence, the government is alleging that Sihpol gamed the mutual-fund system by making profitable "after market" trades, knowing the price at which the market would open the next morning.

Sihpol faces a maximum of 25 years in prison if found guilty of both federal civil and state criminal charges. He surrendered to New York officials on Sept. 16, after being fired by Bank of America a week earlier, along with a handful of other employees, including Robert Gordon, who ran the bank's Capital Management mutual-fund unit, and his boss, Charles Bryceland, who oversaw the New York brokerage operation.

LARGEST PENALTY. In addition to Spitzer's charges, the Securities & Exchange Commission also has weighed in with civil charges agianst Sihpol, claiming that he violated antifraud mutual-fund pricing and broker-dealer record-keeping provisions of federal securities laws. Regulators also say they're considering charges against another former Bank of America employee, Kevin Browne, who worked in broker-dealer services and who allegedly helped to facilitate the trades with Canary.

In a prepared statement, the SEC's Stephen M. Cutler, director of the enforcement division, said: "The conduct alleged is antithetical to what investors expect when they buy or sell mutual funds, which is that each of them will be treated fairly. We will continue to pursue this matter aggressively."

Charlotte [N.C.]-based Bank of America has been hard hit by Spitzer's probe. While asset management is just a small part of the bank's business, the scandal's damage to its reputation "gives the company a black eye," says David Spring, director in the financial institutions group for Fitch Ratings, a New York ratings agency. "They've wanted to build up the asset-management business in general and funds in particular," he says. "This is a setback."

HARDLY "FRINGE SHOPS." Meanwhile, Morgan Stanley has been fined $2 million by the National Association of Securities Dealers, which said the New York securities firm used illegal incentives to encourage its brokers to peddle in-house mutual funds over competing offerings. The penalty is the largest imposed by the NASD involving mutual funds.

Morningstar's Phillips issued a Sept. 15 warning to investors to consider selling shares of mutual funds run by the four firms implicated in Spitzer's original Sept. 3 complaint: Bank of America, Bank One, Janus Capital, and the private firm, Strong Capital Management. "If these were fringe management shops, you could explain it away," says Phillips. "But these are four very prominent, well-respected firms." The quicker regulators can resolve this scandal, the better.

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