DENVER (HedgeWorld.com)–Add Invesco Funds Group Inc. to the growing list of mutual fund companies that have been charged with allowing market timing or late trading of mutual fund shares.
But the fund company, a subsidiary of AMVESCAP plc, London, isn’t going down without a fight.
The U.S. Securities and Exchange Commission and New York State Attorney General Eliot Spitzer on Tuesday leveled federal and state civil charges against Invesco Funds Group and its chief executive, Raymond R. Cunningham.
Both complaints allege Invesco allowed selected institutional investors, including the hedge fund Canary Capital Partners LLC, Secaucus, N.J., to engage in timing trades of Invesco mutual fund shares, in violation of policies outlined in Invesco fund prospectuses.
Mr. Spitzer’s complaint alleges those timing trades, by Canary and others, totaled more than US$900 million between late 2001 and July of this year and cost ordinary Invesco shareholders about US$161 million in fees during that time, plus costs associated with share dilution and other effects. Invesco manages roughly US$18 billion in 48 mutual funds.
Allowing market timing, or quick in-and-out trades of mutual fund shares in order to arbitrage fund net asset values, amounted to fraud on the part of Invesco and Mr. Cunningham, since the fund prospectuses sent by the company did not mention Invesco’s market timing program and in fact gave the impression that Invesco “monitored and discouraged” timing, according to Mr. Spitzer’s complaint.
In a statement issued by AMVESCAP, officials said the actions by the SEC and Mr. Spitzer’s office were not merited and that neither Invesco Funds nor Mr. Cunningham had “engaged in wrongful conduct.”
Company officials blasted the use of “selective civil enforcement actions” and said they supported instead industry-wide guidance from the SEC. Market timing, they added, is not illegal.
Daily liquidity, they said, is a “fundamental feature of any open-ended mutual fund, and absent clear regulatory guidance, should not be needlessly restricted.”
Invesco directed market timers into funds that “would not be adversely affected” by timing activity and kept close track of it, thereby controlling market timers and protecting shareholders, according to the statement.
An internal Invesco investigation documented around 400 instances in which the company closed market timing shareholder accounts when timing activities raised concerns.
AMVESCAP officials also said allowing market timing was within the guidelines of the funds’ prospectuses.
But not everyone at Invesco thought the company had its market timers under control or that that the prospectuses clearly allowed it, according to memos and emails released by Mr. Spitzer’s office as part of its complaint.
Mr. Spitzer’s complaint–the most detailed of the two–cites emails sent between Mr. Cunningham and other Invesco executives, including Chief Investment Officer Timothy Miller, Senior Vice President for National Sales Thomas Kolbe and Michael Legoski, who monitored market timers and closed out those with whom the fund chose not to do business anymore.
“The evidence in this case speaks for itself,” Mr. Spitzer said in a statement.
In one email from Mr. Miller to Messrs. Cunningham, Kolbe and Legoski, Mr. Miller writes that over two days in February (2003) Canary Capital invested and then withdrew US$180 million from Invesco’s Dynamics fund, forcing Mr. Miller to make trades that cost ordinary shareholders “significant performance.”
“These guys [Canary] have no model, they are day-trading our funds,” Mr. Miller wrote. “I had to buy into a strong rally yesterday, and now I’m in negative cash this morning because of these bastards and I have to sell into a weak market. This is NOT good business for us, and they need to go.”
In response, Mr. Cunningham wrote that Canary’s trades were not acceptable. He asked that data be collected so the company could decide how to handle the situation.
Mr. Spitzer’s complaint alleges Canary made 141 separate trades worth US$10.4 billion in and out of the Invesco Dynamics fund between June 2001 and June 2003. That volume of trading is roughly twice the size of the Dynamics fund, Mr. Spitzer’s complaint alleges. Canary realized profits of about US$50 million, or about 110%, on its hedged Dynamics fund trades. During the same period, buy-and-hold Dynamics investors lost 35%, the complaint alleges.
Mr. Spitzer’s complaint also cites a January (2003) memo from Invesco Chief Compliance Officer James Lummanick to Mr. Cunningham in which Mr. Lummanick acknowledges that Invesco funds had become favored among market timers and that market timing violated the company’s prospectus disclosures.
Mr. Lummanick wrote that Invesco officials who dealt regularly with market timers estimated that at any given time between US$700 million and US$1 billion of Invesco mutual fund assets belonged to market timers. The prospectuses said that up to four exchanges were permitted in a 12-month period and that notice of any modifications to or terminations of the exchange policy had to be sent to shareholders at least 60 days prior to the effective date of the change.
“Arguably, Invesco has increased its business risk by granting frequent exceptions to its prospectus policy (effectively changing the policy) without notice to shareholders,” Mr. Lummanick wrote. “While this waiver benefits market timers, it may not be the same thing as acting ‘in the best interests of the Fund and its shareholders,’ and Invesco certainly has not informed investors of a de facto change. Regardless of the level of market timing permitted, Invesco probably should amend its present prospectus disclosure.”
Mr. Spitzer’s complaint alleges that Invesco fund managers had clear monetary incentives to allow market timing. Market timers in most cases agree to put more assets in a mutual fund in exchange for the right to conduct market timing trades. Since mutual fund managers are paid based on fees collected on assets under management, the more assets in the funds, the more the managers would be paid, according to the complaint.
AMVESCAP officials, in their statement, denied the company ever required market timers to maintain other investments in exchange for trading capacity.
Invesco’s Mr. Legoski in October 2001 set forth clear guidelines for allowing market timing at the company, including setting minimum dollar amounts and detailing in which funds timers could invest. Potential fund timers even had to fill out an application form to be included in what Invesco called its “Special Situations” program for fund timers.
This seems to speak to the control aspect AMVESCAP officials referred to in their statement. In the absence of clear regulatory guidelines on market timing, Invesco Funds officials decided to embrace and monitor market timers “rather than remaining vulnerable to uncontrolled short-term traders who would go in and out of the funds when they chose, in dollar amounts they chose, and at a frequency and velocity they chose, all with the potential harm that such uncontrolled trading could cause,” according to the AMVESCAP statement.
“IFG and its employees always acted in good faith and in compliance with its prospectuses, its legal obligations, and most importantly, its fiduciary duty to shareholders,” according to the statement.
Stephen Cutler, director of the SEC’s Division of Enforcement, disagreed. “IFG and its CEO willingly sacrificed the interests of mutual fund shareholders when market timers dangled the prospect of higher management fees in front of them,” he said in a statement. “By granting special trading privileges to selected customers, they readily violated the fiduciary duty they owed to all shareholders and rendered meaningless the funds’ prospectus disclosures on market timing.”