In rapid succession, several market-timing mutual fund cases have come and gone since Gary Pilgrim and Harold Baxter and the Wayne Pa.-based firm that bears their name, Pilgrim Baxter & Associates, were charged with fraud and skirting fiduciary responsibilities by regulators in mid-November, yet the case is still unresolved.
There have been settlement agreements at Alliance Capital, Massachusetts Financial Services, Putnam Investments, and most recently Bank of America and merger partner FleetBoston Financial. A host of others, including Janus Capital, BancOne and Strong Financial, are all said to be nearing conclusions. Yet, Jim Sutcliffe, CEO of Pilgrim Baxter parent company Old Mutual, said last month that a settlement is likely months away for his firm.
Ari Gabinet, the district administrator for the Securities and Exchange Commission's Philadelphia district office, spoke with Money Management Executive Associate Editor Chris Frankie about the timeline in the case, the increased workload in his office and areas in the ongoing fund scandal his office will likely probe -- including best execution and investment houses with both hedge and mutual funds.
MME: Why is the Pilgrim Baxter case taking so long?
Gabinet: I'm not really sure Pilgrim Baxter is taking a longer amount of time.* There was a lot of negotiating that went on with Alliance, and Putnam, of course, has only partially settled.
One thing that makes the Pilgrim Baxter case different is that it's being played out in Federal District Court. The entire backdrop is public, rather than private, and it's in Federal Court where the litigated process is different than the administrative proceedings that the Commission runs.
I think that Pilgrim Baxter is a fund of a different dimension from Putnam and Alliance. Those are firms that are degrees of magnitude larger than Pilgrim Baxter. Although I wouldn't want to underestimate the seriousness of what happened at Alliance, MFS or Putnam, I think that because Pilgrim Baxter was smaller, it is entirely possible that the effects on the fund were not diluted over as many investors as they might have been in a larger fund family.
One other thing to keep in mind is that Gary Pilgrim and Harold Baxter are no longer associated with the firm, and that can change the dynamic of negotiations.
MME: The SEC has spoken at length about how cooperation with regulators is increasingly important. Has cooperation been a problem in the Pilgrim Baxter case?
Gabinet: I wouldn't want to comment on the degree of cooperation while the case is still ongoing. Pilgrim Baxter has filed with the Commission some new prospectus disclosure language that relates to market timing, so I think the parent company certainly is trying to take some affirmative steps.
MME: Can you speak in more general terms about how important cooperation is in determining penalties and remedial action?
Gabinet: Cooperation is important, and it is a subject that has come up with the Commission very recently. The Commission actively quizzes us when we have cases where cooperation is a factor as to whether we've given appropriate credit for cooperation.
There are a number of things that go into the Commission's final analysis and evaluation and it's not just limited to how much cooperation there was in the investigative process. The Commission also looks at whether the problem was detected by the company and did it self-report? Did it have plans in place that would help detect things?
In the whole area of market timing, one of the main criticisms has been that there were these timing police [at the firms] and they were evaded or they were deliberately put on the sidelines so that the fund companies could make more money by having "sticky assets" parked, increasing their fees. That issue could be a factor in assessing the significance of the cooperation in any particular case.
MME: How do you find the correct balance between charging individuals versus charging the firm?
Gabinet: I don't think it's ever clear-cut, but I do think some cases are easier than others. In the case of Pilgrim Baxter, for example, with the allegations that Mr. Pilgrim was a more than 50% shareholder in the hedge fund that was timing the very [mutual] fund that he was the manager of; that is such an obvious conflict of interest that it's not hard to say that's an individual who needs some serious scrutiny.
With an allegation such as the one against Harold Baxter, that he was disclosing portfolio information to Alan Lederfeind at Wall Street Discount, and then Lederfeind was then passing that on to other Wall Street Discount customers, you can imagine the various uses that can be made of that kind of information. Again, that's a very direct and personal kind of a conduct that makes the individual stand out.
Those are the two highest-ranking officers of the firm, so separating the individuals' conduct from that of the firm, or the culpability of the individuals from that of the firm, is difficult because essentially what they do, the firm does, in many instances. There are legal niceties that surround that, and it's not true in every case.
In the case of Putnam, the individuals who were accused of market timing in their own funds were not such high-ranking officers. They were singled out for their conduct, but the firm was charged with a supervisory failure, rather than the same things that individuals did.
MME: The activity alleged against Gary Pilgrim and Harold Baxter is almost unparalleled, with maybe the exception of the allegations made against Dick Strong. Where on the scale of wrongdoing would you rate the allegations in this case?
Gabinet: I think it would be unfair for me to weigh in on that issue in a public forum with a case that's in litigation. I think the allegations in the complaint speak for themselves.
MME: Pilgrim Baxter submitted a filing to the SEC disclosing their anti-market-
timing policies. Does this go far enough to ease future concerns about inappropriate activity at the firm?
Gabinet: Some of it looks similar to the Commission's proposed rulemaking. I wouldn't want to be construed as giving it my approval or disapproval, so it would be inappropriate for me to comment one way or the other on those measures in the abstract.
MME: We have seen an increase in the number of cases and heard that every SEC office is busy working on mutual-fund-related investigations. How many cases is your office working on?
Gabinet: We have mutual fund cases in a variety of areas, including actions against fund complexes and advisors, actions against hedge funds and traders, and actions against intermediaries such as brokers and trust companies. We have investigations in all of those areas, and they are all clustered in one group within our office.
In terms of the number of investigations, I would say that in Philadelphia we have at least a dozen market-timing (including in variable insurance products) and late-trading cases.
The other scandal is on the directed brokerage, marketing side. Of course we broke those cases in this office with the Morgan Stanley case. I would say that our office has got probably close to a half a dozen of those cases going on actively, [as well as] some soft-dollar cases. We probably have close to 20 true mutual fund cases.
MME: Is your office the lead on those, or is that number the total number of cases you are working on, including those that you are investigating in cooperation with other offices?
Gabinet: We are the lead on those. Probably close to half of our workload in this office is on those cases.
MME: What will you be examining going forward?
Gabinet: There are a host of practices our exam program will be looking at, and we intend to go out and do mini-sweeps.
We will look at things like side-by-side hedge fund and mutual fund management, allocation of trades between mutual funds and hedge funds, and brokerage practices as they relate to hedge funds and mutual funds that are side-by-side.
We also have some things in the transfer agent area. But the thing I am most excited about, growing out of the revenue-sharing and directed-brokerage payment, is best execution. It is an area that a lot of people are uncomfortable examining because it can be complicated, but I think that the directed-brokerage cases are giving us a window on best execution, which we would do well to really take a good look through.
*Ari Gabinet's opinions are his own, not representative of the SEC's.
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