Score one for the fund managers.
Bond fund giant PIMCO is off the hook for alleged trading infractions, as New Jersey regulators' assault on the fund complex proved to be a rush to judgment.
New Jersey Attorney General Peter Harvey said last week that his office has dropped PIMCO from its civil lawsuit against several of the firm's affiliates. The move puts an end to a four-month backlash from the Newport Beach, Calif.-based firm's star investment chief, who vehemently denied the allegations and repeatedly forecast that his fund shop would be vindicated.
"[The] announcement to dismiss charges against PIMCO validates what we have said publicly for several months, that we believed when all [the] facts were reviewed carefully against the allegations, New Jersey would conclude no legal violations occurred and no PIMCO bond funds were ever harmed," said Bill Gross, PIMCO's chief investment officer and founder, in a prepared statement.
The Settlement That Wasn't
At issue was the firm's dealings with hedge fund Canary Capital, which the suit claimed was allowed to market time $80 million in the PIMCO High Yield and Real Return funds with up to 12 large round-trip trades each year. PIMCO's prospectus states that it reserves the right to restrict investors to six round-trip trades a year, raising concerns over whether Canary received special treatment.
The Securities and Exchange Commission also examined trading practices at PIMCO, but has opted not to pursue the case. In May, the SEC sued PEA Capital stock funds, but left PIMCO bond funds off the docket. New York Attorney General Eliot Spitzer, who issued a subpoena requesting information from PIMCO, has no plans to bring forth charges against the firm in the near future, according to a source familiar with the matter. Another source familiar with the case, who asked to remain anonymous, said New Jersey regulators "did not complete a full and adequate investigation." That suggests that the New Jersey regulators were a little quick on the draw in their examination in what may have been an attempt to railroad PIMCO.
"State regulators don't have a good understanding of the mutual fund business, so it's easy for them to make mistakes," said Max Rottersman, founder of FundExpenses.com, a New York research firm that analyzes fund fees for institutional clients. "I don't think [Gross] would ever do anything to wreck the return of his fund," he added.
A seemingly rattled Frank Widdman, securities bureau chief at the New Jersey attorney general's office, was careful not to admit that any mistakes were made. "We settled with the firms we were most concerned about. As we got into it, we decided we were going to let them go," he told Money Management Exec-utive, in a telephone interview.
"It struck me as a very, very thin case," said Morningstar analyst Eric Jacobson. "There was exculpatory evidence in the exhibits that suggested there was potential for wrongdoing, but nobody really stepped over the line. I did not see a smoking gun there." In fact, Jacobson pointed out that one of the exhibits contained an e-mail that actually showed one of the PIMCO employees enforcing its compliance policies, telling Canary it must follow the rules of the prospectus.
The Settlement That Was
That is not to say that this was a lost cause for New Jersey regulators. Quite the contrary. PIMCO parent Alllianz Dresdner Asset Management, Connecticut fund marketer PA Distributors and equity fund manager PEA Capital of New York agreed to an $18 million settlement for their respective roles in a fraudulent scheme that permitted Canary to make more than 200 market-timing trades totaling $4 billion. Market-timing capabilities were exchanged for "sticky assets" that generated hefty fees, all at the expense of long-term shareholders.
Under the terms of the deal, the defendants must implement sweeping changes in governance that include an organizational restructuring that will separate the sales arm from the money management group. In addition, Steven Treadway, CEO of PA Distributors, will be forced to resign as chairman of the board of the MMS Funds. Kenneth Corba, who is accused of setting up the quid-pro-quo deals with Canary, resigned as CEO of PEA after the New Jersey suit was filed.
A further stipulation of the settlement is that Allianz be required to hire an independent counsel to conduct an annual audit for the next five years to review the use of redemption fees, fair-value pricing mechanisms and market-timing surveillance regarding MMS Funds. Additionally, the settlement prohibits the disclosure of portfolio holdings of MMS Funds without expressed written consent from Allianz and approved by its general counsel.
Although the settlement included the largest penalty ever collected by New Jersey in a securities fraud case, the dollar amount pales in comparison to some of the huge numbers handed down in recent months. Alliance Capital, for example, forked over $250 million in fines and another $350 million in reduced fees.
"In this particular case, perhaps more out of serendipity than anything else, the losses to the funds weren't that great. In fact, there were some instances where the fund actually made money because the timing was poorly executed and the timer actually lost money," Morningstar's Jacobson said. "In the absence of huge losses, it's harder to justify an enormous sum."
Another point to take into consideration is the size of the firm. 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.