Three former top executives at mutual fund advisory and broker/dealer firm Mutuals.com of Dallas, are reportedly in settlement negotiations with the United States Attorney for the Southern District of New York over criminal securities and wire fraud charges dating back three years.
The Aug. 13, 2004 Federal criminal indictment relates back to market timing and after-hours trading that the three individuals allegedly engaged in for clients using other, non-proprietary mutual funds under cover of the firm's broker/dealer operation, as well as through two affiliated broker/dealers that the firm operated.
Charged were former Chief Executive Officer Richard Sapio, President Eric McDonald and Compliance Officer Michele Leftwich. All were Texas residents.
An official at the U.S. Attorney's office confirmed to MME that the next pre-trial hearing on the case was scheduled for this past Friday, Sept. 7, fueling speculation that a criminal plea of some sort could be close at hand.
In addition, a few weeks ago, Mutuals.com abruptly changed its advisory firm's name to Mutuals Advisors, raising the possibility that the investment firm might be trying to distance itself from its former principals' tribulations. One industry insider with knowledge of the name change, however, said that it was more of an attempt by the firm to let go of outdated references to the dot.com era.
A Washington-based attorney representing all three of the individuals charged had not returned a call seeking comment.
Laurie Roberts, who has served as president and treasurer of the newly renamed Mutuals Advisors since February of this year, declined to comment for this article on the potential impact of settlements or the firm's name change, citing the sensitive nature of the issues.
If settlements are not reached and the three are prosecuted to the full extent of the law, each could face a maximum penalty of 30 years in prison and a fine of $1 million or more on the wire fraud count, plus up to 20 years in prison and a fine of $5 million or more on the securities fraud charge.
The newly named Mutuals Advisors is the investment advisor to the $103 million Vice Fund and its sibling, the $49 million Generation Wave Growth Fund. Neither of the funds themselves, nor the fund advisory company or portfolio managers, had been charged with any misdeeds. Since July 2006, both funds have been subadvised by GNI Capital, an investment firm based in Greenville, S.C., which maintains a local office in Dallas.
The criminal indictment charged the three executives with "participation in a scheme to defraud mutual fund shareholders on behalf of their clients." In fact, the indictment alleged that a significant portion of Mutual.com's business was solely devoted to facilitating market-timing activities within outside mutual funds on behalf of its sophisticated clients. Despite repeated warnings from these mutual fund companies that the quick trading practices would not be tolerated and restrictions placed on Mutual.com's trading, the firm's executives devised ways to circumvent the roadblocks.
These practices included creating multiple accounts for clients, creating two other affiliated broker/dealers to execute trades while concealing their true affiliation with Mutuals.com, using alternative registered representative numbers to avoid being blocked, and executing thousands of trades annually through multiple clearing firms to avoid detection.
The whole matter began in December 2003 when the Securities and Exchange Commission originally filed civil securities fraud charges against the three executives as well as Mutuals.com. The trio subsequently stepped down from their positions in February 2004.
The SEC's action has been stayed until the criminal case has been decided or settled. But the SEC could get the go-ahead to pursue its case, which also charges the three principals with deceptive activities. Regulatory sanctions could include barring each of the executives from holding any position within the industry for life.
The SEC said that over a period of at least two years, from July 2001 to September 2003, the executives engaged in market timing and late trading in hundreds of mutual funds on behalf of at least 18 institutional clients. The SEC found that, among others, Pioneer Investments and Pershing had banned Mutuals.com's activities.
The SEC also charged that the three executives had allowed for late trading. "Mutuals.com [and the two affiliated broker/dealers], at the direction and with the full knowledge, approval and assistance of Sapio, McDonald and Leftwich, enabled their customers to receive same-day NAV pricing on trades that were communicated to Mutuals.com after the close of trading," the SEC said. To conceal the late trading, the SEC alleged, the executives purposefully omitted portions of the trading data they were required to provide to clearing agents.
Despite his official 2004 resignation, Mutuals.com's former CEO Sapio is still involved with the firm, at least pending resolution of the criminal and civil allegations. The renamed Mutual Advisors, as was the previous Mutuals.com, is wholly owned by Mutuals Capital Alliance which, according to the funds' current prospectus, Sapio controls.
The firm's two mutual funds have, so far, survived the ordeal. But there have been dustups. In August 2005, former Vice Fund Portfolio Manager Dan Ahrens who also served as president of Mutuals.com for a time, abruptly left the firm with little explanation [see MME, 9/25/06]. He surfaced a few months later at the helm of his own investment firm and last year launched his new and quasi-competitive Gaming and Casino Fund, which Ladenburg Thalmann Asset Management acquired this past spring [see MME, 3/26/07]. Ahrens continues to sub-advise the fund.
Mutuals.com quickly replaced Ahrens with a short-lived novice fund manager and shortly thereafter hired Charles Norton, principal of GNI Capital to sub-advise both mutual funds.
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