In mid-January, newly appointed Invesco Funds Group chief executive Raymond Cunningham received a confidential memo from his chief compliance officer.
Jim Lummanick warned that frequent trading in Invesco mutual funds was getting out of hand.
Denver-based Invesco had unwittingly ridden an aggressive investment strategy into the gaping jaws of a brutal bear market, chewing up $36 billion in assets under management. With less than $20 billion left, Invesco needed new money.
Yet, Invesco executives appeared conflicted about how to handle market timers, among the few players left willing to invest.
“Arguably, Invesco has increased its business risk by granting frequent exceptions to its prospectus policy (effectively changing the policy) without notice to shareholders,” Lummanick wrote Cunningham.
The level of risk was probably something neither executive could have imagined.
On Tuesday, New York Attorney General Eliot Spitzer and the U.S. Securities and Exchange Commission charged Invesco and Cunningham, 52, with fraud, breach of fiduciary duties and making false statements in registration materials.
“Cunningham was aware of, actively encouraged and expressly permitted market timing by selected traders,” the SEC complaint alleges.
Beyond civil penalties, which could be substantial, regulators want Cunningham to return any compensation Invesco paid him and to be banned for life from the mutual-fund industry that has been his career.
Cunningham was not available for comment.
Yet, former Invesco employees paint a portrait of Cunningham that is worlds apart from a calculating executive who sold out long-term investors to gain a few extra million dollars in management fees.
He is an avid golfer, married to his college sweetheart, and the father of two college-age children. At last year’s company Christmas party, Cunningham encouraged senior managers to buy plane tickets and other nice gifts to raffle off to the staff, said Laura Parsons, who worked closely with Cunningham as a senior vice president before she was laid off.
“He is highly regarded and well-respected,” she said. “He is a great leader, good motivator and good communicator.”
Invesco and Cunningham now find themselves at the center of a legal battle with implications for the entire industry over market timing, the frequent trading of mutual-fund shares that regulators claim dilutes returns and adds costs for long-term shareholders.
Invesco’s policy on market timing states that an investor can make up to four trades in a fund each year. Spitzer’s suit says some timers were allowed to trade as many as 80 times a year.
Invesco isn’t alone in being targeted for striking side deals with market timers. Other large fund families have come under fire, including Denver-based Janus Capital Group, NationsFunds, Putnam, Strong, and Pilgrim Baxter & Associates.
Some fund groups, which had shunned timers when money was pouring in during the late ’90s market boom, became desperate in the slide that followed. They sought any money they could get in the door, money they needed to bolster sagging bottom lines.
Cunningham came to Invesco in June 1999 after working at GT Global, a San Francisco money management firm that Invesco’s sister fund family, AIM Investments, acquired.
He was charged with overseeing the sale of Invesco funds. By May 2001, he was named president. Last January he took over as CEO from Mark Williamson, who received a promotion to run AIM Investments in Houston.
Former Invesco executive Parsons said Cunningham was not the type to sit on problems and let them fester, as the e-mails included in Spitzer’s legal complaint seem to indicate. The complaint refers to repeated warnings from staff and portfolio managers about the dangers of timing.
“When issues were brought to his attention, my experience was that he would fix them,” she recalled.
But another former employee said that as late as last summer, Cunningham ignored a direct plea from a portfolio manager to get rid of the timers.
“Ray knew what he was doing,” said one former portfolio manager who asked not to be named. “It is hard to shed a tear for him.”
Lummanick emphasized in his January memo that Invesco had a way out revise the fund prospectuses as they came up for review.
As written, Invesco had to show that exceptions to its timing policy were in the “best interests of a fund and its shareholders.”
Invesco could shut down the market timers, loosen its policy on frequent trades or change the prospectus language to give it more leeway, getting away from the term “best interests.”
Instead, regulators allege that Invesco chose to keep the agreements secret from average investors and even from the trustees of the various funds.
“Virtually every portfolio manager at Invesco would concede that he or she has had to manage funds differently to accommodate market timers,” Lummanick wrote.
Investors in other funds, not subject to market timing, were enjoying returns as much as 1 percent higher, he noted.
In one particularly damaging contrast, Spitzer’s lawsuit notes that New Jersey hedge fund Canary Capital gained 110 percent trading the Invesco Dynamics Fund during a two-year period. Long-term investors in the fund lost 35 percent.
“I had to buy into a strong early rally yesterday and know I’m negative cash this morning because of these bastards (Canary), and I have to sell into a weak market,” Dynamics portfolio manager Tim Miller complained to Cunningham in February. “This is NOT good business for us, and they need to go.”
Canary’s “timing” capacity was cut from $280 million to $85 million, but despite violating its timing agreement with Invesco, it was allowed to stay around.
The hedge fund finally withdrew after Spitzer’s office began its investigation in July.
Unlike other fund groups that have offered up executives for sacrifice, Invesco’s parent company, London-based Amvescap Plc., and its affiliates have mounted a spirited defense of Cunningham and Invesco. In response to the lawsuits, Williamson wrote a lengthy defense of Invesco and its efforts to control market timing. Invesco did wrestle with market timers, terminating more than 400 investor accounts worth $500 million that it considered harmful, he said.
“Invesco Funds Group never put its financial interest ahead of the best interests of the funds’ shareholders,” Williamson said.