The founders of the Pilgrim-Baxter fund family were charged by state and federal regulators Thursday with improper trading of their funds to benefit themselves and friends at the expense of longer-term shareholders.
The civil actions by the Securities and Exchange Commission and the New York Attorney General against Gary L. Pilgrim and Harold J. Baxter of Pilgrim Baxter & Associates, which manages the PBHG fund family, come a week after both men were forced out of the Pennsylvania company because of the improper trading.
It is the first time that fund company leadership has been directly charged in connection with illegal trading practices. Previously, regulators had taken action against two former Putnam Investments portfolio managers, as well as the firm, but Putnam’s executives were not directly accused.
According to the complaint, the trading arrangements netted those involved more than $13 million in profits, including $3.9 million for Gary Pilgrim alone.
“The top managers of this mutual fund lost their ethical compass and were unable to distinguish between what was in their shareholders interest and their own interest,” New York Attorney General Eliot Spitzer said in a news release.
The two men and their company are charged with committing fraud on federal and state levels, as well as breaching their fiduciary duty to investors. Authorities said they will seek restitution for investors, but did not specify what fines or penalties would be sought.
A call to a Pilgrim Baxter & Associates spokesman seeking comment was not immediately returned.
This is the latest development in the scandal rapidly spreading across the fund industry that long prided an untarnished reputation. Dozens of fund companies have been subpoenaed by the SEC, the states of Massachusetts and New York and other regulators amid reports of widespread improper trading.
Putnam and Canary Capital, a hedge fund operator, have agreed to settlements.
Authorities have also accused some individuals at Fred Alger & Co., Bank of America and Millennium Partners of improper trading. They also have indicated charges are likely against Alliance Capital for improper trading, as well as Richard S. Strong, the founder of the Strong mutual fund company, who has acknowledged making short-term trades to benefit himself and his family.
Congress is considering legislation that would impose penalties for mutual fund trading abuses, make directors on company boards more independent from fund managers and require companies to disclose more information to investors about fees and fund operations.
When Baxter and Pilgrim resigned last week, the company said Pilgrim had agreed to turn over personal profits he received from the improper trading. The company also said it would reimburse the fund all management fees it had earned on the partnership’s trades.
According to papers filed Thursday, Pilgrim, his wife and two other partners established the Appalachian Trails hedge fund, which was permitted to conduct extensive in-and-out trading of PBHG’s funds in violation of PBHG rules that limit rapid trading. The practice, known as market timing is not illegal, but widely prohibited because it skims profits from longer-term shareholders.
The charges also allege that clients of Wall Street Discount, a brokerage run by a close friend of Baxter, were provided with nonpublic information about the portfolio holdings of PBHG funds a process which facilitated the market timing and generated significant profits for these customers.
The arrangements that were engineered or permitted by Pilgrim and Baxter came at a time when their own portfolio managers were complaining that market timing was having a negative impact on returns for typical shareholders and officials banned other market timers, according to Spitzer.
PBHG officials estimated that market timers held $466 million in assets in the flagship PBHG Growth Fund in late 2001. This accounted for more than 14 percent of the fund.
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