Pilgrim Founders Charged

Gary Pilgrim, a highflying mutual fund manager in the 1990s, Thursday became the latest money manager to be charged with wrongdoing in the fund industry’s burgeoning trading scandal.

Pilgrim, who co-founded the PBHG fund group, was charged with civil securities fraud in separate complaints filed by the Securities and Exchange Commission and New York Atty. Gen. Eliot Spitzer. Also charged were Pilgrim’s partner, Harold Baxter, and their firm, Pilgrim Baxter & Associates.

The two men allegedly allowed a hedge fund in which Pilgrim was a major investor to secretly engage in profitable “market timing” of PBHG funds, even though they barred most other investors from doing so.

From March 2000 to December 2001, the hedge fund made 120 short-term trades, earning $13 million for the hedge fund and $3.9 million for Pilgrim, regulators said.

Market timing -- the rapid buying and selling of fund shares in pursuit of quick profits -- is not necessarily illegal. But many funds bar the practice because market timers’ profits come at the expense of long-term shareholders. PBHG investors were “kept in the dark” about the decision to allow timing by a handful of select shareholders, Spitzer’s complaint said.

“The allegations in our complaint describe a course of conduct that was unethical, illegal and just plain wrong,” said Stephen Cutler, the SEC’s enforcement chief.

Regulators are seeking return of ill-gotten profits, repayment of management fees, and unspecified penalties and restitution for PBHG investors.

A lawyer representing the two men did not return a phone call seeking comment.

David J. Bullock, the newly appointed chief executive of Pilgrim Baxter, said in a statement: “The individuals whose conduct is the focus of the complaints have resigned from the company and no longer have any association with Pilgrim Baxter or the PBHG Funds. We remain committed to cooperating with the SEC and New York attorney general to achieve a resolution to this matter, although we do not agree with all the factual allegations or legal conclusions contained in the complaints.”

The charges punctuate what has been a dramatic reversal of fortune for Pilgrim, 63, whose horn-rimmed glasses and intrepid investing style made him one of the bull market’s most recognizable fund managers.

Pilgrim was a momentum investor who gobbled up fast-rising stocks with little regard for a company’s long-term prospects.

The style was perfectly tailored to the manic Internet-stock era, and Pilgrim’s flagship PBHG Growth fund drew legions of “hot money” investors and fawning magazine stories. The fund also was a popular choice for workplace 401(k) retirement plans.

But Pilgrim lost much of his following in the bear market.

PBHG Growth returned 92.5% in 1999 as the bull market was cresting, and the fund’s assets hit $4.4 billion. But the fund skidded 23% in 2000, 35% in 2001 and 30% in 2002, with assets falling to $1.4 billion.

“This is a firm that made a name for itself in the roaring ‘90s with growth momentum stocks,” said Phil Edwards, head of fund research at Standard & Poor’s. “They got the benefit from that but they paid the price.”

Old Mutual, the London-based financial services firm that bought the PBHG fund group in 2000, ousted the two men last week. However, the company said it would pay them $69 million they are owed.

The charges are the latest by state and federal regulators against fund firms and executives over the last 2 1/2 months. The other mutual fund managers charged are two from Putnam Investments.

According to the SEC, Pilgrim initially invested $1 million in the hedge fund, Appalachian Trails, in 1995. Appalachian’s manager told Pilgrim he timed funds, but promised to steer clear of PBHG.

That changed in March 2000 when the manager asked to engage in timing with PBHG funds. Pilgrim consulted with Baxter, who gave his OK, the SEC said.

According to an e-mail written by Pilgrim and released by Spitzer, Pilgrim was well aware of the financial harm that timing could do to shareholders.

“I think timers are a loser for our shareholders and probably not even in our business interests,” he wrote. “So I would give them the boot period.”

The PBHG funds took steps to bar timing by other investors, but made exceptions for Appalachian Trails, regulators said.

Regulators also alleged that Baxter allowed the clients of a personal friend who ran a New York-based discount brokerage firm to time PBHG funds.

Meanwhile, the PBHG charges have brought unwanted attention to Beverly Hills-based Pacific Financial Research Corp., a respected fund advisor.

Pilgrim Baxter uses Pacific Financial Research as the sub-advisor of its PBHG Clipper Focus fund.

Industrywide, companies such as PBHG are farming out portfolio management to sub-advisors as a low-cost way to enhance their fund lineups.

Although there is no indication of improper trading involving PBHG Clipper Focus, at least three class-action lawsuits have been filed against Pilgrim Baxter on behalf of shareholders in all 18 of the PBHG funds, including Clipper Focus.

James Gipson, chief executive of Pacific Financial and the lead manager of PBHG Clipper Focus, said it was unlikely that any timing or late trades involved his fund. PBHG Clipper Focus did not come into the PBHG stable until December 2001, he noted, when Pilgrim Baxter discontinued the trading.