SEC Sues 2 Managers in Case of Alleged Late Trades

The Securities and Exchange Commission on Thursday sued two former hedge fund managers in San Francisco, claiming they used a loophole in a Bear Stearns Cos. trading system to place thousands of illegal mutual fund trades at other investors’ expense.

Brent Federighi, 34, and Michael Hoffman, 42, who managed about $130 million in the Ilytat hedge funds, took advantage of a Bear Stearns system that allowed them to buy or sell mutual fund shares after a 4 p.m. regulatory cutoff, the SEC said in a complaint filed in federal court in San Francisco. The so-called late trades caused about $49 million of losses for the mutual funds and their other shareholders, the SEC said.

“Hoffman and Federighi essentially took money from other mutual fund shareholders to benefit themselves and their hedge funds,” said Helane Morrison, who heads the SEC’s San Francisco office.

Reece Bader, an attorney for Hoffman at Orrick, Herrington & Sutcliffe in Menlo Park, Calif., didn’t return calls for comment. William Goodman, a lawyer at Topel & Goodman in San Francisco who represents Federighi, said he would litigate the case.

“We’re confident it has absolutely no merit and we expect to prevail in court,” Goodman said.

The case against Federighi and Hoffman also sets the stage for a potential settlement of the SEC’s two-year probe of the role that Bear Stearns, the fifth-largest U.S. securities firm, played in the fund trading scandal.

Bear Stearns, based in New York, provided clearing services to clients, including hedge funds, that traded mutual fund shares. Bear Stearns said Dec. 15 that it had offered to pay $250 million to settle with the SEC and the New York Stock Exchange.

Staff at the SEC and the NYSE will recommend the regulators approve the accord and Bear set aside money to pay for it, the company said.

Bear Stearns spokesman Russell Sherman declined to comment Thursday.

The SEC reached a $150,000 settlement Feb. 17 with Brean Murray & Co., a New York brokerage, over allegations the company “aided and abetted” violations by an unnamed clearing firm that processed improper mutual fund trades. That clearing firm was Bear Stearns, people familiar with the situation said at the time.

Federighi and Hoffman placed more than 3,000 late trades in more than 400 mutual funds using Bear Stearns’ mutual fund routing system, the SEC said in its complaint. Trades entered into the system after 4 p.m. “were sent to mutual funds for processing as if they were entered before” the cutoff, the agency said.

Trading fund shares after 4 p.m. New York time, when the next day’s prices are set, allowed the two hedge fund managers to obtain better prices than other investors received, and caused about $49 million in “dilution” to the mutual funds, the SEC said.

Hoffman and Federighi, who managed a hedge fund called Gage Capital after Ilytat closed in 2002, also engaged in rapid, short-term trading known as market timing, the SEC said. Mutual funds prohibited the practice and tried to bar Ilytat and Gage from investing, according to the agency.