Not all scandals are created equal. As such, Invesco Funds is apparently digging in its heels and preparing for a dogfight with regulators, a stark contrast to the "yes siring" going on at firms accused of more outrageous activities.

So far bad-boys Putnam, Strong and Pilgrim Baxter have been charged with self-dealing, while Bank of America's NationsFunds is being investigated for illegal late trading and market-timing. Other firms have come under fire for the more "garden-variety" market-timing schemes in that they failed to disclose their short-term trading arrangements in their funds' prospectuses.

"Using inside opportunities to fleece one group of your customers to benefit another group is the worst kind of fraud," said Melvyn Weiss, a partner at Milberg Weiss of New York, one of the dozens of law firms that have filed suit against fund companies. He noted that self-dealing is so clearly over the line that there is no discrepancy over the language contained in a prospectus. Still, buying under a false prospectus meets the definition of securities fraud, Weiss added.

Invesco, a unit of the UK's Amvescap and MFS Investments, the mutual fund arm of Canada's Sun Life, are the latest firms to incur the wrath of regulators. Invesco has been formally charged with securities fraud while MFS has received word from the SEC that charges are imminent. The charges brought by state and federal regulators against Invesco allege the firm made millions of dollars from market-timing arrangements in which preferred customers were allowed to trade rapidly in and out of its funds. It did so despite objections from its compliance officer and other employees that had knowledge of the illicit trades.

In one of several condemning e-mails detailed in the complaint, one executive wrote that market-timing was "killing the legitimate shareholders." The case differs from previous allegations against mutual fund firms in that Invesco was not charged with any other wrongdoing such as self-dealing or late trading. The complaint hinges on the fact that the company failed to adequately represent the shareholders of its funds, thereby shirking its fiduciary responsibility.

In another memo, Tim Miller, Invesco Funds' chief investment officer and manager of the company's Dynamics and Technology funds wrote, "These guys are day-trading our funds and I know they are costing our legitimate shareholders significant performance. I had to buy into a strong early rally yesterday, and now I'm in negative cash this morning because of these bastards and I have to sell into a weak market. This is NOT good business for us, and they need to go."

According to its prospectus, Invesco pledged that it would not allow any more than four exchanges out of its funds in a 12-month period. Nevertheless, the company made cushy deals with dozens of institutional clients over several years allowing them to make over 80 trades a year, the New York complaint said. The deals were known internally as "Special Situations" and were executed with the knowledge of the company's executive suite including CEO Ray Cunningham. Market-timing of Invesco funds totaled approximately $900 million in assets in 2003, Spitzer's office estimated.

Still, Invesco has maintained its innocence saying that the language in its prospectus served as a "guideline" for investors and that it reserved the right to amend its exchange policy. Britain's Amvescap said it actively pursued market timers in its funds: "An initial litigation complaint is designed to set forth only one side of a controversy and often utilizes information taken out of context. Invesco never put its financial interest ahead of the best interests of the funds' shareholders. This was most clearly demonstrated by Invesco's actions in terminating relationships with shareholders who held in excess of $500 million of assets that posed a potential threat to the funds."

The company's top compliance officer wrote in an email that these special situations might be "contrary to the prospectus language" and "not in the best interest of non-market-timing shareholders." So while there was no outright fraud, the case boils down to semantics and whether or not the company will be held to the language scripted in the prospectuses. He also noted that an internal review of market-timing revealed that institutional portfolios without market-timing arrangements produced returns 75 to 100 basis points higher than timed retail portfolios.

Contingency Plan For AIM

Meanwhile, AIM Investments, a sister company and distributor of Invesco's mutual funds, has prepared a contingency plan in the event that regulators strip it of its investment advisor license. According to Section 9 of the Investment Act of 1940, if Invesco were found guilty of fraud charges and banned from serving as an adviser to any 1940 Act fund, AIM would suffer the same fate. In an effort to stave off that scenario, the Houston-based company indicated that it plans to seek exemptive relief if those circumstances indeed arise. However, there is no guarantee that the SEC would grant the exemption, the company said.

A spokesman for the company said a ban is not a likely scenario and that the firm's actions are merely a precautionary measure. "Invesco and AIM believe that the SEC charges are without merit and Invesco intends to defend them vigorously. The proceedings remain at a very preliminary stage. It is important to note that Invesco has not yet had the opportunity to file its defenses or present its case in court," said Ivy McLemore.

Since the charges were brought against Invesco there have been no major staff departures, which suggests that it intends to hold its ground and fight. Whether the firm is found guilty or not, a prolonged legal battle could draw more negative publicity.

Read The Fine Print

MFS' circumstances are a little different. According to a set of instructions given to its brokers, MFS cleared five of the company's biggest mutual funds to accept short-term trades even if "excessive trading was detected." However, that information never found its way into the funds' prospectuses, which explicitly state that its funds "do not permit market-timing or other excessive trading practices."

Invesco did not say it did not allow market-timing, a fact that will certainly strengthen its defense against the allegations. The more restrictive language in MFS' prospectus lends itself to more intense scrutiny from regulators because it is in direct contradiction with its written timing policies. MFS said it is fully cooperating with regulators.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.