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Massachusetts Regulators Say A.G. Edwards Condoned Market Timing

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BOSTON (–Massachusetts’ chief regulator, Secretary of the Commonwealth William F. Galvin, filed an administrative complaint Wednesday alleging three employees of St. Louis-based A.G. Edwards & Sons Inc. ran a market-timing operation out of the firm’s Back Bay office that benefited two offshore hedge funds.

According to the complaint, Mr. Galvin’s Securities Division began looking into the market-timing arrangement in December 2003 after learning that an A.G. Edwards employee had been fired for “business practices incompatible with those at the firm.” The Securities Division filed the complaint based on conclusions it reached as a result of the investigation.

The complaint alleges A.G. Edwards “created a system and a culture” that allowed one employee, a financial consultant named Charles A. Sacco, to conduct tens of thousands of market-timing trades on behalf of two hedge fund clients: Headstart Asset Management, London, and Atlantique Capital, based in the Caymans. Both funds used market timing– the rapid buying and selling of mutual fund shares to take advantage of short-term price movements–as their chief strategy.

According to the complaint, Mr. Sacco opened 162 separate trading accounts for various Headstart funds and conducted about 28,600 trades for those accounts between June 2002 and October 2003. Those trades were placed among more than 300 separate mutual funds in 60 mutual fund families. The total value of all the trades was nearly US$4 billion.

Mr. Sacco also opened 34 separate accounts for Atlantique Capital, using them to conduct about 2,400 trades in a four-month period between May 2003 and September 2003. The trades occurred in nearly 140 mutual funds in 26 fund families. Total value of the trades, according to the complaint, was roughly a quarter of a billion dollars (US).

As a result of his productivity–Mr. Sacco was one of A.G. Edwards’ top performers during this period–he moved in to an office with windows and received letters of congratulations from the Back Bay office’s regional manager, Bill Branson, according to the complaint.

Facilitating the trades was not easy, particularly when the mutual funds whose shares the hedge funds were timing began cracking down on the rapid trades. According to the complaint, as many as 23 of the mutual fund companies detected Mr. Sacco’s market timing and either complained directly to A.G. Edwards officials or blocked the account numbers and sent so-called block letters to A.G. Edwards. Most of those block letters were sent to the firm’s St. Louis headquarters, according to the complaint.

Mr. Sacco “had a huge financial incentive to conceal his market-timing activities from the mutual fund companies,” according to the complaint. So he covered his tracks by changing numbers used to track traders so they wouldn’t match numbers in the mutual funds’ systems. He also used multiple account numbers and transferred money from accounts that had been identified as timing accounts into other accounts, a procedure known as “journaling.”

The complaint also alleges Mr. Sacco’s immediate supervisors–Albert A. Fagan III, who worked as the Back Bay office’s branch manager from August 2000 to March 2002, and Jeffrey K. Robles, who took over from Mr. Fagan as branch manager–reviewed and approved Mr. Sacco’s trading arrangements. Mr. Galvin’s office alleged Messrs. Fagan and Robles, and corporate higher-ups, either overlooked or signed off on his behavior, and ignored the complaints, block letters, emails and phone calls from angry mutual funds.

In August 2002, an employee at John Hancock Funds LLC, Boston, emailed a member of A.G. Edwards’ fund sales team and identified Mr. Sacco and others at A.G. Edwards as “notorious market timers.”

Two months later, a representative from Hartford Funds, which oversees management of mutual funds run by The Hartford Financial Services Group Inc., Hartford, Conn., called and threatened to block all trades originating in A.G. Edwards’ Back Bay office if Mr. Sacco’s market timing continued.

In June 2003, State Street Research, Boston, placed a “redemption only” order status on all of A.G. Edwards’ Back Bay branch accounts, meaning no purchases of mutual fund shares would be allowed by anyone at that office.

In response to all this, A.G. Edwards’ Back Bay office stopped trading Hartford and State Street Research mutual fund shares but did nothing else to curb the market timing in other funds or to further supervise Mr. Sacco, according to the complaint.

All this transpired despite the fact that A.G. Edwards senior officials began in December 2002 to seriously discuss market timing and its effect on customers. In April 2003, the company drafted a memo on “excessive mutual fund trading” that clearly outlined the company’s policy, specifically that it did not want to “attract or assist” market timers and that it would no longer accept timing accounts and would require current timers to transfer their assets to other firms, according the complaint from Mr. Galvin’s office.

Nevertheless, Mr. Sacco continued to market-time mutual funds on behalf of Headstart and Atlantique until he was fired in October 2003 following an internal investigation. Also in October, Mr. Sacco agreed to a one-year suspension levied by the NASD for his market timing activities, although he did not admit to or deny the allegations.

Messrs. Sacco, Fagan and Robles were not charged in the complaint filed by Mr. Galvin’s office.

The A.G. Edwards case has two other prominent connections to a broader mutual fund market timing and late-trading probe launched in 2003 by New York State Attorney General Eliot Spitzer and the U.S. Securities and Exchange Commission. Martin Druffner, an employee at Prudential Securities who was named in an earlier complaint by Mr. Galvin’s office alleging Prudential helped hedge fund clients make market timing arrangements, was named in the A.G. Edwards complaint as the man who referred Headstart to Mr. Sacco.

And Michael Sassano, formerly with the Canadian Imperial Bank of Commerce and who allegedly referred Headstart to Druffner while at CIBC, also has ties to Atlantique and to Chronos Asset Management Inc., Cambridge, Mass., another hedge fund that has been accused of market timing.

In a statement released late Wednesday, A.G. Edwards officials said they would defend themselves against the allegations made by Mr. Galvin’s office. A.G. Edwards spokeswoman Margaret Welch said in the statement, “It’s important to note that this complaint states the alleged activities occurred over a year ago and involved one branch, two clients and a financial consultant who was terminated by the firm in October 2003.”

The complaint seeks to require A.G. Edwards to stop current and future market timing and pay fines and penalties to compensate mutual fund shareholders harmed by the practice. Market timing is not illegal, but it is believed to harm ordinary mutual fund shareholders by diluting their share value and saddling them with the costs of the trades.

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


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