BOSTON (HedgeWorld.com)–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.