Pimco Mutual Funds May Face Charges
The Pimco mutual fund group, one of the biggest and most respected names in the financial services industry, was told by federal regulators Thursday that it might be charged with wrongdoing in the mushrooming fund-trading scandal.
The investigation by the Securities and Exchange Commission and a parallel probe by the state of New Jersey threaten to push Pimco into a maelstrom that has battered the fund industry and damaged the reputations of more than a dozen other companies.
Pimco, the nation’s fifth-largest mutual fund family, disclosed that it received formal notice from the SEC that it might face civil charges related to an allegedly improper market-timing arrangement.
The company also acknowledged that it had, in fact, permitted market timing to take place in three of its stock funds in 2002. Yet it stressed that investors suffered no losses and that the timing activity was no longer taking place.
Market timers rapidly buy and sell mutual funds in hopes of profiting from short-term movements in stock prices. Timing itself is not illegal. But many fund companies have stated policies of either barring the practice or strongly discouraging it, and could be misleading customers by secretly making exceptions for favored investors.
Market timing can hurt individual investors in several ways, including by forcing the fund to bear extra transaction costs. Timers’ profits, regulators contend, come straight out of the pockets of long-term fund holders.
Pimco made its disclosures after inquiries from the Los Angeles Times.
Though securities regulators were known to be investigating some aspects of Pimco’s dealings as part of a broad look into the industry, the company had largely managed to stay above the fray.
“You don’t expect the good guys to do things like this,” said Roy Weitz, head of FundAlarm.com, a mutual fund watchdog website. He added that the news “is going to shock a lot of investors.”
The best-known part of the Pimco operation -- the Newport Beach-based bond trading desk run by investment guru Bill Gross, a familiar face on CNBC’s business news shows -- does not appear to be the main focus of regulators’ scrutiny. Instead, they seem to be zeroing in on Pimco’s stock funds, which are run out of New York.
Nonetheless, the fact that the funds share the Pimco name could be damaging to Gross’ bond offerings, which are a staple in corporate retirement plans. In some investors’ eyes, said Geoff Bobroff, a mutual fund consultant in East Greenwich, R.I., “Pimco is Pimco.”
An SEC spokesman in Washington declined to comment, as did Randall Lee, head of the SEC’s Los Angeles office. Franklin Widmann, chief of the New Jersey Bureau of Securities, could not be reached for comment.
According to people familiar with the inquiry, the SEC and New Jersey are investigating whether Pimco allowed Canary Capital Partners, a hedge fund run by Edward Stern, to market-time some equity funds. In exchange, Canary made long-term, multimillion-dollar investments in other Pimco stock funds, one source said. Such “sticky asset” deals benefit fund companies because the long-term investments can generate hefty management fees.
Hedge funds are lightly regulated investment pools used primarily by wealthy individuals and institutions. Stern, grandson of the founder of the Hartz Mountain pet-supply empire, was among the first to be ensnared in the mutual fund scandal last year, when New York Atty. Gen. Eliot Spitzer began shining a spotlight on the industry’s trading practices. Though he did not admit wrongdoing, Stern agreed to a $10-million fine for improper trading by Canary, plus $30 million in restitution for the hedge fund’s alleged illegal profits.
Phil Neugebauer, a Pimco spokesman, confirmed that PEA Capital, a money management unit that runs Pimco stock funds, allowed Stern to market-time three of them: Pimco PEA Target, Pimco PEA Growth and Pimco PEA Opportunity.
However, the company said in a statement that it forced Stern out of the funds in late 2002 -- a year before the fund scandal broke.
The stock funds run by PEA and the bond funds managed by Pimco are both marketed to individual investors under the Pimco name. Both units are owned by Allianz Dresdner Asset Management, an arm of Allianz, a German insurance company.
Stern approached PEA with a request to market-time funds and to make long-term investments in other funds, Neugebauer said. He said there was no quid pro quo requiring the long-term investment in exchange for market-timing capability.
“PEA believes its employees have followed company guidelines,” the firm’s statement said, “and have not permitted illegal or inappropriate trading practices that would have harmed funds or their shareholders.”
But regulators are unconvinced, one source said, adding that they believed the relationship between Canary and the Pimco funds should have been fully disclosed to investors.
Eventually, Stern’s trading was judged to be “inconsistent with the company’s core business” and he was asked in October 2002 to withdraw his money, PEA Capital said. A Canary spokesman declined to comment.
Stern earned less than $1 million in one fund and lost large sums in the two others, which resulted in a collective loss, Neugebauer said. The firm has not paid restitution to the fund in which Stern made a profit, he said.
PEA Capital said it hired a Boston law firm, Ropes & Gray, to undertake an internal investigation. The probe found no instances of late, after-the-bell trading, an illegal practice also at the core of the fund scandal, PEA said. It did not find any evidence of market timing by PEA employees, the company added.
PEA Capital also said that its fund prospectuses did not prohibit market timing but said that the company could bar timers if their activity was determined to be “detrimental.” However, the prospectus for the three funds also said they could refuse to do business with any investor doing more than six “round-trip” trades within 12 months.
Some experts said the alleged deal with Stern may have been an attempt to lure investors to Pimco stock funds, which have been overshadowed by the success of the bond unit.
Pimco stressed Thursday that the bond fund operation was completely separate from the equity unit involved with Canary. Some saw that as a savvy public relations move.
“It’s a smart argument to make, because their crown jewel is the bond department,” said Don Phillips, managing director at fund tracking firm Morningstar Inc. “You’d want to protect them and put up any sort of wall between the bond department and any sort of misdeeds.”
