Invesco, CEO Face Civil Charges in Mutual Fund Scandal

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.”

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