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Phoenix: Settlements Out of Way, Fireworks Approac

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TORONTO (–After years of settling what can be settled, the Ontario Securities Commission has narrowed down the questions arising from the demise of Phoenix Fixed Income Arbitrage LP.

As a result, a contested hearing involving the alleged loose cannon trader Stephen Duthie and a hedge fund that expired in dramatic fashion in January 2000 may begin later this month.

The OSC approved the settlement of the matter as against Mr. Duthie’s supervisor, Ronald Mock, April 9.

The parties agreed to the basic facts. Phoenix Fixed Income Arbitrage operated under the managerial umbrella of the Phoenix Research and Trading Corp. Mr. Mock was responsible for all of the fixed-income business of Phoenix Research, including that relating to the fund. Between late 1998 and early January 2000, Phoenix Fixed Income Arbitrage held long positions in various U.S. benchmark treasuries, including 6% U.S. Treasury notes due Aug. 15, 2009. The trading in those positions was directional, unhedged and violated the fund’s investment parameters in concentration, size, length of time held, and value at risk; the long bond positions were never marked to market.

Mr. Mock neither checked the inputted prices, nor verified that they were being independently checked. The inaccurate pricing resulted in an overvaluation of PFIA’s U.S. portfolio by more that US$80 million as of Dec. 31, 1999. In January 2000, as a result of an overdraft at the Bank of New York, Phoenix Research liquidated all of PFIA’s assets at a loss in excess of US$125 million.

Mr. Mock maintains that he believed that the impugned treasuries were not outright bond purchases, but reverse repos. This belief was contrary to Phoenix Research’s books and records. In short, Mr. Mock failed to supervise in any meaningful way a trader with just more than one year of fixed-income arbitrage experience and his failure was material to the collapse of PFIA.

Last summer, the OSC settled similar failure-to-supervise charges against the former chairman of Phoenix Research, Mark Kassirer, and against its former director of operations and finance, (John) Blair Taylor, Previous HedgeWorld Story.

The Main Event

All these settlements are preliminaries to the main event. Each amounts to an agreement with supervisory personnel to the effect that Mr. Duthie was a rogue trader, and his nominal supervisors were at fault for allowing him to become a rogue. Mr. Duthie does not agree with that characterization and the contested hearing said likely to get underway later this month would give him an opportunity to paint a very different picture.

Mr. Duthie could not be reached for comment, but in interviews he gave soon after the melt-down, Previous HedgeWorld Story, he outlined his position.

He will likely contend that his supervisors had begun a shift in the style of PFIA in 1998. They had been disappointed in the 1997 results under the original market neutral strategies and the redemptions that resulted. They continued to be disappointed with the first quarter 1998 results, a return of less than 1%. But with the more aggressive directional style, the fund returned 3.71% in the second quarter. By the time of the sudden reversal of fortunes in January 2000, “I had been carrying a long directional position in 10-year U.S. government securities over at least five month-ends,” Mr. Duthie said.

“This was a position size in excess of US$3 billion that we were rolling mostly by overnight repo. There is no way in a small office of just 13 people–with the principals of the firm sitting three feet from me–that they did not know the manner in which I was trading.”

A trader who worked at PFIA until about 18 months before its collapse offered his own account. He said that while he was there, into the summer of 1998, he saw no evidence of style drift. When he left, he said, the strategy was completely market neutral and well defined as such. This would seem to weaken part of Mr. Duthie’s argument. On the other hand, this former trader said that PFIA was a small shop, of around 12 people in his recollection, and that as a result everybody tended to know what everybody else was doing. That might seem to strengthen another part of Mr. Duthie’s argument.

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