State, federal and securities regulators converged on the mutual-fund industry yesterday, bringing criminal and administrative charges against a former Bank of America official for allegedly helping a hedge fund illegally trade after hours, and fining Morgan Stanley $2 million to settle charges it offered brokers prizes for steering investors to specific mutual funds.
New York Attorney General Eliot Spitzer and Securities and Exchange Commission Director of Enforcement Stephen Cutler stood side by side at a news conference announcing their joint action against former Bank of America broker Theodore Sihpol III. The case marks the first time Spitzer has brought criminal charges in his 2-year-long Wall Street probe, and the joint announcement with the SEC reflects how seriously federal regulators are taking allegations that Canary Capital Management was offered trading opportunities unavailable to normal investors.
In a separate action, the NASD, which polices broker-dealers, took Morgan Stanley to task for what Vice Chairman Mary Schapiro called “clear violations” of a 1999 rule against offering broker non-cash incentives for selling particular mutual funds. The rule’s intent is to prevent brokers from steering investors to funds that might not be appropriate investments.
The NASD complaint details 29 contests with $1 million in prizes ranging from Los Angeles Lakers basketball tickets to Nordstrom gift certificates.
Taken together, the actions add up to one of the worst days in recent history for the mutual-fund industry, which depends on small investors for its survival.
The investigations could damage investor confidence at a time when small investors are returning to stock mutual funds, said Jacob Frenkel, a former SEC enforcement lawyer. “Most mutual-fund investors have believed until now that the mutual-fund system was the safest mechanism for investing in the market. Now they can no longer believe that,” he said.
The SEC, Spitzer, Massachusetts regulators and Manhattan U.S. Attorney Jim Comey all are investigating allegations of mutual-fund abuses ranging from improper broker incentives to secret deals that allowed hedge funds to engage in short-term trades that siphon profits from buy and hold investors.
“This is an investigation with an ever-widening reach. Information that is interesting to us is continuing to pour in at a rate that is surprising to us,” said Spitzer.
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