Wall Street Firm Settles Trading Accusations

Times Staff Writer

Wall Street brokerage firm Bear Stearns & Co. has agreed to pay $250 million to settle charges that it executed improper mutual-fund trades that allowed hedge funds to make hundreds of millions of dollars in profit at the expense of individual investors, regulators said Thursday.

The Securities and Exchange Commission and New York Stock Exchange alleged that from 1999 to 2003, Bear Stearns let hedge funds engage in late trading and market timing, twin practices that enable professional traders to earn fast profits at the expense of long-term mutual-fund shareholders.

Bear Stearns designed special systems to accommodate the trading, then helped hedge funds disguise their activities and circumvent restrictions that mutual funds put up to block them, according to regulators.

Hedge funds often pursue complex trading tactics in hopes of big returns for their clients, which include wealthy individuals and pension funds. In some cases, managers showed their appreciation by giving Bear Stearns employees tickets to sporting events and gift certificates to spas, the SEC said.


“This type of behavior is completely outrageous and unacceptable,” said Richard Ketchum, regulatory chief at the New York Stock Exchange.

Bear Stearns neither admitted nor denied the charges and declined to comment on the settlement. It had announced the outline of the deal in December, saying that it was in the best interests of shareholders and clients. Its shares dipped 94 cents Thursday, to $133.27.

The settlement came the same day Bear Stearns reported first-quarter profit of $514 million, more than double the amount of the settlement, or $3.54 a share. That was 36% higher than the $379 million, or $2.64, it earned a year earlier.

The settlement includes a $90-million fine and disgorgement of $160 million in ill-gotten gains. The restitution will go into a fund to be distributed to the harmed mutual funds and mutual-fund shareholders.


Late trading, which is illegal, involves buying or selling mutual-fund shares after the stock market closes at 4 p.m. Eastern time but receiving the current-day price. Investors who enter fund orders after 4 p.m. are supposed to get the price that is effective at the following day’s market close. Securing the pre-close price allows a trader to benefit from late-breaking news, such as a corporate earnings release, that others couldn’t act on.

Market timing involves the rapid purchase and sale of mutual-fund shares in the hope of profiting from short-term market swings. The practice is not illegal, but many fund companies bar market timing because gains come at the expense of long-term shareholders.

Part of the evidence was gathered from taped phone conversations in which Bear Stearns employees pitched their late-trading or market-timing capabilities to customers. Trading desks often tape phone conversations to ensure that orders are processed correctly if a dispute arises later.

In one call, a Bear Stearns employee told an outside broker, “We probably do the best clearance there is on the Street on market timing,” adding that, “You have plenty of time to do trades ... pretty much a quarter to six, 5:45, to enter a trade.”


The exposure of late trading and market timing in 2003 by New York Atty. Gen. Eliot Spitzer rocked the mutual-fund industry. Several fund companies paid big fines after it was revealed that they had secretly abetted the improper activity, often in exchange for investors agreeing to put money into their start-up funds. In a few cases, mutual-fund insiders traded for their personal gain.

Although Bear Stearns itself did no trading, it was a linchpin for wrongdoing by others, according to regulators.

Bear Stearns is one of several firms that dominate the mundane but profitable business of processing, or “clearing,” securities trades. Clearing firms handle recordkeeping and paperwork for trades done by hedge funds, small brokerage firms and others. That perch gives clearing firms a vantage point to monitor customer trading and the ability to condone, or shut down, improper behavior.

In 1999, Bear Stearns agreed to pay $38.5 million to settle charges that it turned a blind eye to fraud at A.R. Baron, a brokerage for which it cleared trades.


Clearing contributed 12% of Bear’s first-quarter revenue.