New York State Attorney General's Case aga

Mr. Spitzer said that Mr. Stern evolved and improved his trading strategies to achieve these above-market results by relying on negotiated private deals. Early in his money management career he followed a simple timing method of buying a small-cap technology fund when the market was going up and selling it when the market began to decline. He had an understanding with a senior fund executive that allowed him to do this.

Through the years Canary searched for such opportunities and even engaged a consultant devoted exclusively to looking for timing capacity, the complaint says. By July 2003, the firm had negotiated, directly or through intermediaries, timing capacity agreements with around 30 mutual fund families, many involving quid pro quo “sticky asset” investments in the funds.

Mr. Stern also conducted below radar trades that are difficult for the target mutual funds to detect. Bank of America and Security Trust Co., an Arizona trust administrator, intermediated such trades in addition to facilitating late trading. Canary also relied on other brokers such as Kaplan & Co. Securities Inc. and JB Oxford & Co. for late trading.

But the hedge fund manager’s most extensive relationship was with Bank of America, the complaint says. Starting in 2001, the bank set Canary up with a state-of-the-art late trading platform, allowing it to trade late in hundreds of mutual funds offered to the bank’s customers; gave it permission to time its own Nations mutual funds; provided US$300 million of credit to finance the trading; and sold derivative short positions.

“In the process, Canary became one of Bank of America’s largest customers,” according to the prosecutor. This relationship was mutually beneficial to Canary and various parts of the bank. Theodore Sihpol III, a broker at Banc of America Securities, coordinated all the activity. At one time Mr. Sihpol commented that Canary’s requests were “a bit unorthodox,” but stated that the manager was willing to play by the guidelines and pay for value added.

Procedures Canary was allowed to use violated SEC rules and the Nations Funds prospectus and were never disclosed to mutual fund shareholders. Timing privileges given to Canary were controversial within the bank, according to e-mail messages obtained by Mr. Spitzer’s office. One employee complained that this client was doing extremely short-term trades in and out of a Nations midcap index fund, sometimes holding only a day, and the cost was being borne by other fund shareholders.

In early July 2003, Canary received a subpoena from the New York Attorney General and stopped timing Nations Funds. At that time, the bank’s “timing police,” which was supposed to stop abuses, noticed that Canary’s sticky assets had left the bank.

Canary has agreed to make restitution of US$30 million in illegal profits and pay a $10 million penalty. Mr. Stern and his employees are providing the prosecutor with evidence in an ongoing investigation of the mutual fund industry.

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