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Pilgrim-Baxter Founders Agree to Record Market-Timing Fine

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WASHINGTON (–Congratulations, Dick Strong. You’re no longer at the top of the list of mutual fund executives who’ve had to reach into their own pockets to pay fines and penalties for allowing market timing.

Number One with a bullet this week are Gary L. Pilgrim and Harold J. Baxter, co-founders of the mutual fund firm Pilgrim Baxter & Associates Ltd., Wayne, Pa. Thanks to a US$160 million settlement with the Securities and Exchange Commission and the New York State Attorney General’s office announced today, Messrs. Pilgrim and Baxter now hold the distinction of having forked over the most personal money to settle mutual fund market-timing charges.

As part of the agreement the two men will pay a total of US$80 million apiece in restitution and civil penalties for their roles in allowing outsiders to market-time mutual funds run by Pilgrim Baxter & Associates. Additionally, both men agreed as part of the settlement to lifetime bans from the securities industry. Neither man admitted to nor denied the allegations made by the SEC and New York State Attorney General Eliot Spitzer.

The penalties, combined with the US$90 million in restitution, fines and civil penalties that Pilgrim Baxter & Associates (now called Liberty Ridge Capital) agreed to as part of a separate market-timing settlement back in June, bring Pilgrim Baxter’s total shareholder restitution to US$250 million. As with previous settlements, the money from the fines and restitution will be returned to investors harmed by the market timing. In addition, Pilgrim Baxter agreed to lower its mutual fund management fees by US$10 million as part of its settlement.

Mr. Strong earlier this year agreed to pay US$60 million to settle charges he market-timed his own firm’s mutual funds. Mr. Strong also issued a personal apology as part of the settlement.

The giant personal penalties to be paid by Messrs. Pilgrim and Baxter speak to the severity of their abuse of shareholder trust, said Stephen M. Cutler, director of the SEC’s Division of Enforcement, in a statement. “The amounts being paid in this settlement are virtually unprecedented for individuals in civil cases,” Mr. Cutler said. “Along with the permanent bars, the monetary sanctions we have obtained here reflect the severity of the misconduct and the fundamental breach of duty at issue in this case.”

Added Mr. Spitzer: “As founders of a company that bore their names, Mr. Pilgrim and Mr. Baxter should have set an example of integrity and fair play. Instead they were at the center of improper conduct that deceived and harmed their clients.”

Investigations by Mr. Spitzer’s office and the SEC found that despite mutual fund prospectuses that claimed investors in PBGH funds would be allowed to make no more than four trades per year into and out of Pilgrim Baxter mutual funds, certain investors were allowed to break the rules.

Among those investors were friends of Messrs. Pilgrim and Baxter. One friend of Mr. Baxter, Alan Lederfeind, ran a New York brokerage called Wall Street Discount Corp. Mr. Baxter ordered Pilgrim Baxter to provide Wall Street Discount with price and holding information not available to the public, which Mr. Lederfeind passed on to his clients, who in turn used it to conduct market timing of PBGH funds, according to the SEC.

Additionally, Mr. Pilgrim was an investor in the hedge fund Appalachian Trails LP, which was allowed to conduct market timing of PBGH funds, including the PBGH Growth Fund, which Mr. Pilgrim managed.

SEC officials said Appalachian Trails made 120 trades and earned about US$10 million in profits. Meanwhile, Mr. Pilgrim reaped close to US$4 million in personal profits.

Market timing consists of rapid in-and-out trading of mutual fund shares in order to take advantage of price changes. Many mutual fund prospectuses discourage the practice and some prohibit it. Regulators say it harms ordinary mutual fund shareholders by cutting into performance and passing the trading costs on to those shareholders.

SEC officials claimed Messrs. Pilgrim and Baxter also profited personally from the market timing by selling their respective interests in PBA revenue, which grew as a result of the increased advisory fees the firm was generating due to the market-timing activity.

To date, more than a dozen mutual firms have settled market-timing charges with the SEC and Mr. Spitzer’s office. According to a release from the New York State Attorney General’s office, the settlements have so far generated US$1.17 billion in restitution, US$821 million in civil penalties and US$925 million in negotiated mutual fund management fee reductions, for a total settlement value of close to US$3 billion.

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Contact Bob Keane with questions or comments at: [email protected]