In the strongest crackdown yet in the unfolding mutual fund scandal, regulators on Tuesday ordered the shutdown of a Phoenix financial services company that is accused of helping a hedge fund engage in illegal trading.
Security Trust Co., which served as a middleman between mutual funds and investors in corporate retirement plans, was ordered by federal banking regulators to liquidate its operations by March 31. The firm was charged with helping Canary Capital Partners engage in the late trading and market timing of mutual funds.
The order by the Office of the Comptroller of the Currency came as New York Atty. Gen. Eliot Spitzer lodged criminal fraud and larceny charges against Security Trust’s former chief executive and two other former executives. They could face as many as 25 years in prison if convicted of larceny, the most serious charge. The Securities and Exchange Commission brought civil fraud charges against the company and the former employees.
“Security Trust Co.'s conduct caused direct harm to thousands and thousands of ordinary mutual fund investors around the country,” said Randall Lee, head of the SEC’s Los Angeles office. “This action is significant because it illustrates yet another means by which ordinary long-term investors have been cheated.”
The punishment is the toughest to be meted out by regulators in the 3-month-old mutual fund debacle. It is the first action against a fund intermediary, and it opens a window into a murky world that regulators fear may have facilitated much of the improper trading that they are uncovering in the fund industry.
Intermediaries such as trust companies and retirement plan administrators handle the behind-the-scenes process by which millions of employees with retirement plans such as 401(k)s buy and sell fund shares each day. The firms lump together thousands of individual orders and send them to fund companies for final execution.
The arrangement allows account holders in a retirement plan to make trades without requiring the plan provider to maintain a trading operation. Fund companies benefit from working through an intermediary because they may have to process only a few large trades from a particular 401(k) plan, rather than thousands of smaller trades.
Security Trust, a 12-year-old firm with about $13 billion in custodial assets, had intermediary relationships with about 2,500 retirement plan administrators and other customers.
In a statement, Security Trust said many of the regulators’ allegations were true but stressed that the former management team had been replaced and the wrongdoing stopped.
Security Trust said it would work with authorities for an “orderly dissolution” of the company.
According to the SEC, Security Trust routinely sent trading orders from Canary to mutual fund companies after the stock market had closed for the day, but at that day’s closing price. Such late trading is illegal.
Security Trust often passed the trades off as those of individual investors in retirement plans that had been sent before the market close, the SEC said, when in reality they had been sent in after the close by Canary, which sought to profit from late-breaking market developments.
The SEC said 99% of Canary’s trades were sent in after the 4 p.m. EST close, and 82% between 6 p.m. and 9 p.m.
Regulators also alleged that Grant Seeger, Security Trust’s former CEO, helped Canary engage in so-called market timing, the rapid purchase and sale of fund shares, in some cases devising strategies to conceal the timing from the funds themselves. Market timing typically isn’t illegal, but many fund companies discourage their investors from engaging in it.
According to the SEC, Security Trust went to great lengths to help Canary Capital complete its improper trading, and later tried to cover its tracks after some of its own employees raised questions. Canary is the hedge fund run by Edward J. Stern, scion of one of America’s wealthiest families, that was first targeted by Spitzer when he unveiled his fund industry probe in early September.
From May 2000 to last July, Security Trust earned $5.8 million by helping Canary trade in 397 mutual funds, according to the SEC. Canary, which paid $40 million to resolve Spitzer’s charges, earned $85 million.
Attorneys for Seeger and William A. Kenyon, Security Trust’s former president, did not return calls.
Don Martin, an attorney for Nicole McDermott, Security Trust’s former senior vice president, said his client was innocent and that she had tried to expose some of the wrongdoing.
“She had the good sense and the moxie to go to others and say, ‘This doesn’t seem right,’ ” Martin said. “In the face of that, I find it extraordinary that two days before Thanksgiving [the regulators] would choose to bring criminal and civil charges against somebody who tried to blow the whistle.”
Separately on Tuesday, Pittsburgh-based Federated Investors Inc. disclosed that it had arrangements with Canary and other unnamed hedge funds to permit market timing in some Federated stock mutual funds in the first half of this year. The firm said two officers who arranged the trading had resigned.
Federated also said that an employee had admitted deleting e-mails relevant to the firm’s investigation of the trading. That person was fired, the firm said.
As regulators’ probes of the fund industry have widened since Spitzer announced his investigation on Sept. 3, criminal charges have been filed against former employees of Bank of America Corp. and Millennium Partners for their alleged roles in trading arrangements.
Civil charges have been filed against fund companies Putnam Investments and Pilgrim Baxter & Associates.
Regulators have said many more cases were pending.
Times staff writer Josh Friedman in Los Angeles contributed to this report.