BofA Broker Charged in Illegal Fund Trading
New York Atty. Gen. Eliot Spitzer’s probe of the mutual fund industry yielded its first criminal prosecution Tuesday when a former Bank of America Corp. broker was charged with helping a well-heeled investment firm conduct illegal fund trading.
In a complaint filed in state court in Manhattan, Spitzer accused the ex-broker, 36-year-old Theodore Sihpol, of grand larceny and securities fraud, alleging that he helped a private investment group, Canary Capital Partners, engage in the late trading of mutual funds. The Securities and Exchange Commission filed a separate civil action against Sihpol.
The criminal complaint comes two weeks after Spitzer rocked the $6.9-trillion mutual fund industry by revealing his investigation into whether a wide swath of fund companies let privileged customers engage in trading practices that collectively may have cost small investors billions of dollars.
Spitzer told reporters at a Manhattan news conference that his investigation “is likely to result in numerous other charges.”
“This is an investigation with an ever-widening reach,” Spitzer said, adding that information “continues to pour in at a rate that is surprising.”
Sihpol’s attorney, Don Buchwald, said his client would plead not guilty at a preliminary hearing scheduled for Friday.
“Ted sought and obtained approval for Canary’s trading procedures from all appropriate personnel and levels at the bank,” Buchwald said. “Under these circumstances, given the absence of criminal intent on Ted’s part, we believe that proceeding against him with a criminal complaint was inappropriate.”
Sihpol, who lives in New Canaan, Conn., gave himself up to authorities in Manhattan on Tuesday morning. He was arraigned in the afternoon, but was expected to spend the night in jail after being unable to finalize bail, Buchwald said.
Sihpol probably will put up $50,000 this morning to satisfy the $750,000 bail, Buchwald said.
The charges against Sihpol were a dramatic reminder that the mutual fund industry, which has escaped much of the scandal that has singed Wall Street in recent years, suddenly finds itself squarely in the sights of Spitzer and other regulators.
The Securities and Exchange Commission has requested information on trading practices from scores of mutual fund companies and SEC Chief William Donaldson has pledged to cooperate with state regulators in policing securities markets.
Spitzer gained national recognition last year when he spearheaded a probe of Wall Street stock analysts, which resulted in a $1.4-billion settlement with 10 major brokerage firms over conflicts of interest. But Spitzer never brought criminal charges against any firm or individual stock analyst.
The speed with which Spitzer brought the current action sets it apart from the analyst investigation and gives an indication of the attorney general’s strategy, said David Robbins, a Manhattan attorney and former New York state prosecutor.
“The reason he brought the case so quickly is to scare the mutual fund industry and have them knock on the door of his office and say, ‘We did this too, and here’s the information,’ ” Robbins said.
According to the court documents, Sihpol was a broker for Bank of America’s Manhattan operation that catered to wealthy individual investors. In April 2001, he solicited business from Canary Capital, a hedge fund run by Edward J. Stern, the son of a Manhattan real estate mogul.
When he unveiled his probe two weeks ago, Spitzer announced a $40-million settlement with Canary, which he accused of engaging in both late trading and mutual fund timing.
In late trading, which is prohibited by federal and New York state laws, favored investors are allowed to buy or sell mutual fund shares after the stock market has closed, but at that day’s 4 p.m. EDT closing price rather than the following day’s closing price, as required by law.
The practice can provide an unfair advantage by enabling late-trading investors to profit from late-breaking news -- such as a bullish earnings announcement that would push a stock’s price up the next day -- by buying at the current day’s lower price. Other fund shareholders, meanwhile, would have to buy at the next day’s closing price, after the stock had already run up.
Timing, which involves the rapid-fire trading of fund shares, isn’t illegal. But many fund companies discourage the practice because it is thought to hurt the returns of buy-and-hold investors. And any fund company that selectively condoned fund timing could have violated its fiduciary duties to investors.
At the April 2001 meeting, Stern asked whether Bank of America could help his hedge fund engage in fund timing, using BofA’s Nations Funds as vehicles for the investments. Sihpol got approval from his supervisors, according to court documents, and the arrangement later resulted in Sihpol’s helping Canary engage in late trading.
According to court documents, Sihpol told investigators that Canary would give him or one of his employees a list of trades before 4 p.m. that the hedge fund was contemplating. Sihpol would put a pre-4 p.m. time stamp on each trade order.
But Sihpol told investigators that he would not place the orders until he and Canary spoke by phone after 4 p.m. At that time, Canary would tell him which trades to finalize. Sihpol would discard the order tickets for trades Canary did not want and would process the remaining orders with the pre-4 p.m. time stamps.
Spitzer has alleged that officials at Charlotte, N.C.-based BofA allowed Canary to engage in illicit after-the-bell trading in exchange for investing long-term assets in other BofA mutual funds, generating asset-based fees for the bank.
Sihpol was dismissed by Bank of America last week, along with two of his superiors and several other people. A company spokesman said Tuesday that the bank was cooperating with investigators.
“We are moving diligently to address any issues within our company in order to maintain the trust of our customers,” the spokesman said.
If convicted, Sihpol would face 8 1/3 to 25 years in prison on the larceny count and 1 1/3 to four years on the fraud charge.