Three firms affiliated with PIMCO equity funds agreed to pay $50 million to settle fraud charges related to a market-timing scheme that bilked long-term shareholders.
As part of a settlement with the Securities and Exchange Commission announced last Monday, PIMCO affiliates PA Fund Management (PAFM), PEA Capital and PA Distributors will pay $40 million in penalties and $10 million in restitution. The three PIMCO entities, wholly owned by German insurer Allianz Dresdner Asset Management, were also ordered to beef up their internal compliance and governance systems. The companies neither admitted nor denied any wrongdoing.
The announcement comes just two months after the firms agreed to pony up $18 million to settle similar charges brought by New Jersey regulators. PIMCO, the bond fund giant run by famed portfolio manager Bill Gross, was not named in the SEC settlement and was dropped from the New Jersey lawsuit in early June due to lack of evidence.
As a result of an internal review, the PIMCO affiliates earlier this year paid $1.6 million to reimburse fund shareholders harmed by the market-timing arrangement. The SEC said it would give the firms credit against their disgorgement obligation, thereby reducing the balance owed to $48.4 million.
"PEA, and more strongly Allianz, wanted to put all this behind them," said Morningstar analyst Eric Jacobson. "They were willing to do almost whatever it took to change operations, bring in new people and add things regulators would be comfortable with." Stephen Cutler, director of the SEC's division of enforcement, called the settlement "a resounding victory for mutual fund shareholders [that] includes sizeable monetary sanctions, restitution for shareholders of the affected funds and far-reaching structural reforms."
The SEC brought the charges against the firms for allowing a hedge fund, Canary Capital Partners, to trade in and out of its Multi-Manager Series Funds in exchange for $27 million in sticky assets in an equity mutual fund and a hedge fund from which PAFM and PEA earned management fees. This arrangement was not disclosed in the funds' prospectuses and long-term shareholders were given the impression that PIMCO funds discouraged or limited market timing.
From February 2002 to April 2003, Canary made more than 100 round-trip exchanges in excess of $4 billion in several PIMCO equity funds as part of its exclusive timing deal. This was not a case of the firms being lax in enforcing its policies because they were vigilant in preventing hundreds of other account holders from engaging in the same behavior by issuing warning letters, blocking trades and freezing accounts, according to the settlement document.
Still pending are charges against Stephen Treadway, former chairman of the PIMCO funds and head of fund sales, and Kenneth Corba, the erstwhile chief executive of PEA. Treadway is accused of giving the go-ahead on the Canary deal in January 2002 but failing to disclose the arrangement until September 2003, at which point New York Attorney General Eliot Spitzer had already launched a widespread investigation into mutual fund trading practices. Corba is alleged to have been the point man for the operation, negotiating and approving the timing and sticky asset arrangement with Canary. Their attorneys could not be reached for comment.
The SEC also accused PEA of disclosing material, non-public information regarding portfolio holdings to the broker executing Canary's trades, a blatant violation of securities law. "It's illegal for a mutual fund advisor to share non-public information with a favored investor," said Randall Lee, regional director of the SEC's Pacific regional office. "This $50 million settlement reflects their serious breach of trust."
But the SEC offered very little detail on the alleged wrongful disclosure aside from a blanket statement about the release of the portfolio holdings. "It wasn't entirely clear that brokers representing Canary actually were given preferential portfolio access," Jacobson said. He noted that monthly portfolios were being sent to consultants, his own firm Morningstar and other information providers, suggesting that the portfolio holdings were pretty widely available. "My sense is that PEA really wanted to get this over with even if they didn't agree with the SEC's assessment, rather than trying to pick that one specific point and trying to fight it," he said.
Perhaps even more heavy-handed than the fines in this case are the compliance and oversight reforms imposed on the three PIMCO affiliates. The firms are required to have a board of trustees made up of at least 75% independent directors and headed by an independent chairman, criteria the SEC approved on Sept. 7. In addition, within 90 days of the settlement order, the firms must organize a compliance and ethics oversight committee as well as an internal compliance controls committee made up of senior executives of the operating business.
And within 60 days, the affiliates must hire an independent compliance consultant to whom employees can convey concerns about questionable behavior. The firm will also undergo an intense review process. Other measures the three firms must take include an annual compliance review conducted by a disinterested third party, hiring an independent distribution consultant within 30 days of the order and several other reforms involving certification and recordkeeping.
"The settlement involves some really rigorous oversight," Jacobson said. "There are all these tripwires built in to the SEC mandate that require a lot of extra reporting on the part of the PEA folks to the independent directors."
While a number of fund complexes slapped with fraud charges have suffered substantial outflows, PIMCO equity funds have weathered the storm. Funds bearing the PEA name took in $1.17 billion so far this year on the strength of John Schneider's $6 billion Renaissance Fund. Without that offering, however, the PEA funds managed to reap only $117 million in new money.
Despite Morningstar's sell recommendation, investors for the most part decided to hang onto their funds. PEA is a relatively small company compared to some of the other fund shops that have been implicated in the scandal, housing roughly 30 employees in its money management group and a few billion dollars in assets. The departure of Corba and Treadway has had a much more comforting effect than it would at a large firm such as Putnam, where Larry Lasser's departure failed to ease investor concern.
Separately, the three PIMCO affiliates have also settled another set of allegations concerning shelf space payments, which will cost them another $20.6 million in disgorgement and penalties. The SEC and California Attorney General Bill Lockyer fined the company $11.6 million and $9 million, respectively, for failing to disclose how they directed trades to 50 broker/dealers between 2000 and 2003 to defray shelf space costs.
As for the PIMCO brand name, Jacobson said Allianz will likely keep PIMCO equity funds under the same structural umbrella as the bond fund unit, but they're going to do more work to delineate the brand names to make clear the separation of responsibilities. A spokesman for PEA did not return phone calls seeking comment.