The Securities and Exchange Commission yesterday filed civil fraud charges against five former brokers and a branch manager at Prudential Securities’ Boston office for defrauding dozens of mutual funds and their shareholders.
The SEC accuses the former brokers of “misrepresenting their own identities or the identities of their brokerage customers” to engage in thousands of so-called market-timing trades.
Massachusetts securities regulators filed a separate but related civil complaint against former Prudential brokers and managers, also charging them with securities fraud.
The news came on a day when Newark-based Prudential Financial reported better-than-expected earnings for the third quarter.
Market timing the practice of trading quickly in and out of mutual funds to take advantage of price lags is not illegal. But both the SEC and Massachusetts regulators allege the traders hid their actions and used false identities to disguise their activity from fund companies that prohibit it. And that, regulators said, is a violation of securities laws.
“By concealing or misrepresenting their own identities or the identities of their clients, the defendants were able to circumvent restrictions intended to protect mutual-fund shareholders against excessive market timing,” said Stephen Cutler, director of the SEC’s Division of Enforcement. “That’s fraud, plain and simple.”
The former brokers facing securities fraud charges are Martin Druffner, Justin Ficken, Skifter Ajro, John Peffer and Marc Bilotti. Also charged were Robert Shannon and Michael Vanin, former branch managers, who allegedly assisted the brokers in the improper trades.
Both the SEC and Massachusetts filed charges against Druffner, Ficken and Ajro. Only the SEC charged Peffer and Bilotti. Massachusetts, meanwhile, filed the only charges against Vanin.
Prudential spokesman Bob DeFillippo said the company is fully cooperating with the Massachusetts investigation, but could not comment on either of the two complaints filed yesterday.
Regulators said that over a two- year stretch ending in September, at least 68 mutual fund companies sent letters to Prudential Securities complaining about improper market-timing trades made by brokers in the firm’s Boston office.
In their complaint, Massachusetts authorities allege Prudential Securities received as many as 30,000 letters from mutual fund firms warning that its brokers were engaged in improper market timing, but the company did nothing to stop them.
The charges are the latest twist in an unfolding series of investigations into widespread trading abuses within the $7 trillion mutual fund industry.
Although Prudential was not named as a defendant, the SEC and Massachusetts regulators criticized the company for turning a deaf ear to many of the complaints registered by the mutual fund firms.
“Despite the incredible influx of these letters, Prudential never took any action to curtail the root of the warnings the deceptive and unethical business practices by the Druffner group in contravention of fund rules,” the Massachusetts complaint said.
The brokers operated under at least 62 different broker identification numbers, the complaint says, and Prudential did nothing to halt or discipline them even after warning that market timing would not be tolerated.
Prudential Financial’s proprietary mutual fund business is based in Newark and is separate from the retail stock brokerage operation. In July, Prudential closed a deal with Wachovia to merge their retail brokerage businesses. Wachovia owns 62 percent of the merged firm, called Wachovia Securities.
As part of the Wachovia-Prudential deal, pre-existing legal liabilities are the responsibility of the parent company in this case Prudential, according to a Wachovia spokesman.
Since early July, William Galvin, Massachusetts’ secretary of the commonwealth, has been investigating individual brokers at Prudential’s Boston office.
Galvin announced the investigation after New York Attorney General Eliot Spitzer’s launched a sweeping examination of sweetheart deals between mutual funds and professional investors at hedge funds.
The charges against the former Prudential Securities brokers overshadowed what was an otherwise strong third quarter for Prudential Financial, which released its earnings report after the market closed yesterday.
Prudential said third-quarter net income for its financial services businesses fell 41 percent, to $230 million, compared to $392 million during the same period last year. The figure includes a $20 million charge associated with the sale of its reinsurance business three years ago. It also includes a $36 million charge associated with closing a number of stock brokerage offices in Europe.
On an adjusted operating income basis, the picture was far brighter, with earnings up 19 percent to $361 million, or 70 cents a share, compared with $303 million, or 54 cents a share, a year ago. On that basis, Prudential beat by 14 cents the consensus forecast of Wall Street analysts.
Prudential Chairman and Chief Executive Arthur Ryan said the company expects to achieve earnings per share in the range of $2.40 to $2.50 for 2003, based on adjusted operating income.
Assets under management were $421 billion as of Sept. 30, up 16 percent from $363 billion a year earlier.
“The numbers are pretty darn strong,” said analyst Colin Devine at Smith Barney Citigroup. “Operationally, Prudential continues to gather steam.”
Still, Devine said the actions brought on by the SEC and Massachusetts regulators would probably overshadow the company’s financial results during a conference call with analysts this morning.
“We certainly find it disturbing if the regulators are correct and Prudential received 30,000 letters of complaint,” he said. “That’s mind- boggling.”
Devine said he also was concerned that Prudential has re-hired Michael Price, the former president of Wachovia Securities who left last week amid regulatory inquiries into his role in the market-timing scandal at Prudential Securities.
Rice, a former Prudential executive and one of the chief architects of the joint venture between the two firms, is returning to Prudential as a senior managing director in charge of Prudential Securities “legacy issues,” including litigation.
“Our calls to the company on this issue were not returned,” Devine said. “And, unfortunately, it is these events that may overshadow what was really a good quarter.”