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Where the Buck Stops: B of A Says It Will Seek Compensation from Other Funds

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CHARLOTTE, N.C. (–Bank of America Corp. officials said they will seek reimbursement from hedge funds and other investors that used the bank’s trading systems to conduct market timing of mutual funds outside B of A’s own Nations Funds complex.

Bank officials made the vow in a statement released the same day that Securities and Exchange Commission officials and New York State Attorney General Eliot Spitzer announced a US$455 million settlement with the bank over charges it allowed hedge fund Canary Capital Partners LLC, Secaucus, N.J., to conduct market timing and late trading of its Nations Funds mutual funds Previous HedgeWorld Story.

In settling with the SEC, Bank of America agreed to pay US$250 million to reimburse mutual fund investors harmed by market timing and late trading. Of that amount, about US$25 million would go directly to Nations Funds mutual fund shareholders. The remainder would be paid to shareholders of other external mutual funds in which market timing and late trading were conducted through Bank of America’s Broker Dealer Services clearing broker trading systems.

The bank also will pay a US$125 million fine. The money from the fine and the reimbursement will go into a government-administered fund and then be distributed to shareholders, said Robert Stickler, Bank of America spokesman.

Additionally, Bank of America will sell the broker-dealer clearing service that hedge funds and other investors used to time B of A mutual funds and other external mutual funds. Mr. Stickler described the business as a small part of Bank of America’s overall operations and unrelated to the bank’s other clearing services.

In a separate agreement with the New York State Attorney General’s office, Bank of America agreed to reduce the fees it charges mutual fund investors by US$80 million over the next five years.

And eight of the Nations Funds’ board members will resign or leave the board by the end of this year in connection with their granting of market-timing capacity to Canary.

Canary has thus far been linked to late trading and market-timing allegations at 10 mutual fund companies. Bank of America’s relationship with the hedge fund was among the first disclosed by Mr. Spitzer’s office. In a September announcement of a settlement with Canary, and in a felony complaint against B of A broker Theodore C. Sihpol, the attorney general detailed the hedge fund’s ties to Bank of America.

Mr. Sihpol executed mutual fund trades on behalf of Canary and later helped Canary install an automatic system so the hedge fund more easily could execute its mutual fund trades, according to the attorney general’s complaint against Mr. Sihpol.

Canary traders would call Mr. Sihpol and read him a list of proposed mutual fund trades for a given day. Although Mr. Sihpol filled out trade tickets for each proposed trade and gave the trades time stamps, he would not place them right away. Instead he waited until after 4 p.m. ET, when he received a phone call from a Canary representative telling him which of the proposed trades Canary wanted executed. Mr. Sihpol would then submit the appropriate trade tickets. Although the tickets were submitted after 4 p.m., they had a pre-4 p.m. time stamp.

Mr. Spitzer’s office charged that this amounted to late trading–in effect, trading mutual fund shares at yesterday’s price with tomorrow’s information because mutual fund share prices are set at 4 p.m. ET each day. Late trading is illegal.

Mr. Spitzer likened late trading of mutual fund shares to betting on a horse race after the horses had crossed the finish line.

The automatic system Mr. Sihpol helped install at Canary allowed the hedge fund to trade mutual fund shares at the 4 p.m. cutoff price until 6:30 p.m. ET, according to a complaint filed by Mr. Spitzer’s office against Canary. In return for timing capacity in B of A’s Nations Funds, Canary invested millions of dollars of long-term, or so-called “sticky” assets, in Bank of America bond funds, thus increasing the value of those funds and delivering more management fees to B of A managers, the complaint alleges.

And Canary also used Bank of America’s broker-dealer clearing service, as well as one run by Security Trust Co. NA, Phoenix, to conduct market timing of mutual fund shares. Market timing is not illegal, but the quick in-and-out trades of mutual fund shares to take advantage of price movements are thought to hurt long-term investors by passing on the costs of the trades to long-term shareholders and sapping performance. B of A earned money from the processing of Canary trades.

In its complaint against Canary, Mr. Spitzer’s office characterized Canary’s late trading and market-timing relationship with Bank of America as the hedge fund’s “most extensive.” It included a US$300 million line of credit extended to Canary by B of A to finance late trading and market timing of Nations Funds.

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