First Guilty Plea in Funds Probe
The first guilty plea came Thursday in the widening investigation of trading schemes involving shares of mutual funds, as a former employee at prominent hedge fund Millennium Partners admitted to making illegal after-hours trades.
Steven B. Markovitz, 41, who pleaded guilty to one felony count of securities fraud in state court in Manhattan, is the second person to be charged with criminal violations stemming from late trading -- the most flagrant abuse alleged by New York Atty. Gen. Eliot Spitzer when he uncovered the scandal a month ago.
Markovitz also agreed to cooperate in Spitzer’s probe.
Spitzer said Thursday that illegal after-hours trading -- a practice he likened to “betting on yesterday’s horse race” -- appeared to have been more common in the $6.9-trillion mutual fund industry than he and others initially realized.
“The late-trading issue is radiating out in a way that is surprising to many of us,” he said. “The information about other entities involved in late-day trading is disturbing because of the harm it does to investors.”
With the help of unspecified brokers, Markovitz bought shares of mutual funds after the 4 p.m. market close in New York, but at prices set at the end of that day’s trading session, according to the complaint. By law, shares bought or sold after the market closes should be priced at the next day’s closing price. The scheme allowed Millennium to take advantage of market-moving news that occurred after the markets closed.
A person close to the investigation said late trading was lucrative for Markovitz, whose annual compensation swelled from about $200,000 in 1999 to as much as $10 million in recent years, in part because of the strategy.
Markovitz, who left the $4-billion Millennium fund in mid-September, could face up to four years in prison. New York Supreme Court Judge James Yates has not scheduled sentencing.
Markovitz’s attorney, Thomas Fitzpatrick, declined to comment, as did a spokesman for New York-based Millennium Partners, which has not been charged.
Millennium, founded in 1989 by Israel Englander, has racked up stellar long-term returns for its well-heeled investors. Hedge funds are loosely regulated investment pools catering to clients with at least $1 million in assets.
The mutual fund scandal erupted Sept. 3, when Spitzer alleged that a fast-trading hedge fund, Canary Capital Partners and its manager, Edward Stern, were allowed by Bank of America Corp. to engage in illegal after-the-bell trading in BofA’s Nations Funds.
In addition, Spitzer said, Canary was allowed to engage in quick “market-timing” trades in and out of funds run by Janus Capital Group Inc., Strong Capital Management and Bank One Corp., as well as Bank of America.
Market timing is not illegal, but it can drive up transaction costs for all shareholders, eroding long-term returns for buy-and-hold investors, and most funds have policies against it.
Canary paid $40 million to settle the charges, without admitting guilt.
According to academic studies cited by Spitzer when his inquiry was disclosed, late trading may cost U.S. investors $400 million a year and market timing may siphon off $4 billion to hedge funds and other traders.
On Sept. 16, former Bank of America broker Theodore Sihpol was charged by Spitzer with larceny and securities fraud for his role in the Canary scheme. Sihpol has pleaded not guilty.
Spitzer said Markovitz’s guilty plea sends a strong message to the mutual fund, hedge fund and brokerage industries, where more indictments could hit as the probe continues.
“It should be eminently clear that we are seeking serious sanctions,” Spitzer said. “The information is flowing in at a remarkable rate, and there should be an expectation of solid cases to come.”
Unlike in his Sept. 3 complaint against Canary, Spitzer declined Thursday to name the mutual fund companies involved, saying they may have been duped because the late trades were disguised.
One source said funds run by Alliance Capital Management were among several Markovitz used. Alliance may not have known about the late trades, however, because they were believed to have been processed through third parties.
An Alliance spokesman declined to comment. In a separate matter Tuesday, Alliance suspended two employees after uncovering “conflicts of interest” in the trading of its fund shares.
Bank of America and Prudential Securities also have suspended or fired employees as a result of internal investigations of fund trading.
“There is a significant amount of self-examination, as there should be,” Spitzer said.
Financial services giant Citigroup Inc. joined that list Thursday, saying it fired a broker at its Smith Barney unit for canceling mutual fund trades after the market close. Citigroup reportedly was quickly subpoenaed by Spitzer’s office, although a company spokeswoman declined to comment.
Other regulators also are looking into mutual fund trading, including the Securities and Exchange Commission.
In settling corresponding civil charges brought by the SEC, Markovitz agreed to a lifetime bar from association with any investment advisor or mutual fund. The SEC will seek repayment of ill-gotten profits and civil penalties still to be determined, the agency said.
Stephen M. Cutler, director of the SEC’s division of enforcement, hinted that the federal agency could bring more late-trading cases. “We will continue to pursue abusive trading practices involving mutual funds to ensure that investors are treated fairly,” he said.
