In an effort to stave off a lengthy stint in prison, former Bank of America broker Theodore Sihpol has asked a New York judge to dismiss criminal fraud charges against him, according to a motion filed by his attorney last week. Although he argues that accepting trades after 4 p.m. has never been illegal, industry experts don't think this premise will hold up in court.
Sihpol, 37, is facing up to 25 years in jail for grand larceny and another four years for falsifying records. He was arrested and subsequently fired by BoA in September 2003 after being identified by regulators as the key player in a scheme that allowed hedge fund Canary Capital Partners to trade fund shares after the market close while still receiving that day's price.
While Canary and Bank of America each have reached settlements with New York Attorney General Eliot Spitzer's office without admitting or denying any wrongdoing, Sihpol remains on the hook for criminal charges, which amount to 40 counts of securities fraud. His trial is scheduled to begin Feb. 7.
In a memorandum of law submitted to Justice James A. Yates of the Supreme Court of New York, Sihpol's attorney argued that the charges should be dropped because his client was not made aware that his actions constituted criminal behavior.
"Mr. Sihpol is being prosecuted for alleged activities that never were considered criminal, prohibited by the securities laws or deemed improper prior to his arrest in September 2003," said C. Evan Stewart, Sihpol's attorney and a partner at New York law firm Brown Raysman Millstein Felder & Steiner.
Sihpol's defense hinges on the contention that the allegedly illegal trades were placed prior to the setting of the funds' net asset value (NAV) and that the law does not contain a specified cutoff time for receiving orders. Rule 22c-1 of the Investment Act of 1940 stipulates that a fund's NAV be computed at least once daily "at the specific time or times during the day that the board of directors of the investment company sets."
Sihpol's defense team notes that the Securities and Exchange Commission did not provide sufficient interpretative guidance on late trading prior to the Canary settlement nor had it brought any enforcement actions related to that issue. In fact, the SEC issued a number of no-action letters over the past two decades reinforcing the notion that rule 22c-1 requires fund orders to be priced at the NAV "next computed" after the receipt of the order and that the Rule was designed to ensure "forward pricing." So as long as an order was accepted prior to the NAV pricing, it was considered consistent with full compliance.
After the trading transgressions at Canary were unearthed, the SEC conducted a survey of fund companies and found that more than 25% of mutual funds had customers that placed or confirmed orders after 4 p.m., and still received the 4 p.m. NAV. And despite having been granted tremendous authority under the Martin Act, New York's attorney general has never brought charges on the basis of late trading.
In the memo, Stewart further disputed the grand larceny charges brought against his client on the grounds that New York courts have ruled consistently that the value of property stolen in a larceny is the difference between what the victim paid for the product and what the value the victim would have received in the absence of the scheme. In this case, Spitzer is accusing Sihpol of "stealing" over $1.25 billion worth of mutual fund shares from six fund companies.
Stewart argues that these shares were merely transferred from the fund to Canary in exchange for the required sum of money needed to purchase those shares. In other words, it was a simple transaction Sihpol conducted without pocketing any of the money or the shares. Stewart called Spitzer's interpretation of larceny in this case "wrong and unprecedented."
Another sore spot for Stewart is the attorney general's assertion that Sihpol be held liable for trades made on the electronic trading system BoA used to process Canary trades. "There is no evidence to support claims that Mr. Sihpol had any involvement in the configuration, installment, operation or maintenance of that system, or that he was in any way qualified to do so," the memo states.
On top of that, Stewart noted that Sihpol was the most junior person involved in the company's dealings with Canary, often deferring to more senior persons within the firm for approval and advice, notably compliance chief Gerald Timmons, Charles Bryceland, head of the New York private client group, and Michael Tierney, a BoA managing director. Many of the decisions associated with the Canary account were made during meetings with senior management, who often excluded Sihpol from their discussions. In other words, there was plenty of blame to be passed around.
Still, the general consensus of mutual fund observers is that trading fund shares after the closing bell is definitely not on the up and up. "If his case is as weak on the criminal part as it is on the improper part, it's a terrible defense," said Roy Weitz, a lawyer, CPA and founder of FundAlarm.com, who said he found Stewart's claim that late trading was not improper "amusing." Ten out of 10 fund watchers would agree that late trading is wrong, he said.
"It strikes me as sort of a bluster defense," Weitz said. "If you have a weak case, then you get in the other guy's face and try to stare him down. If this went to a jury trial, it would be a pretty easy issue for a jury to understand. I think from a populous sense, that this would be a slam-dunk case for the prosecution. But I always thought this was better as a civil fraud case."
Weitz expressed a certain level of sympathy for Sihpol, given the leniency afforded to other fraudsters such as PBHG founders Gary L. Pilgrim and Harold J. Baxter, whose misdeeds were arguably much more egregious. Pilgrim and Baxter have been banned from the securities industry for life and forced to pay $160 million in fines, but were not charged with a crime for their self-dealing and market-timing transgressions.
Weitz noted that the timing of the BoA revelations played a hand in the seriousness of the case, as the firm and Sihpol were among the first blips on Spitzer's radar screen. "He got hit hard because he was early," Weitz said. He also believes that the attorney general was "picking the low-hanging fruit."
Nevertheless, Sihpol was in a different position than Canary, which was in the business of taking advantage of every financial opportunity it encountered. Sihpol, on the other hand, had a fiduciary responsibility to investors as an employee of the bank. Blatantly disregarding shareholder interests, misleading investors and ignoring industry best practices makes a strong case for fraud. "He was clearly doing something he should not be proud of," Weitz said.
Ultimately, this case is not likely to be dismissed. "Judges generally don't like to stop a trial before anyone has had a chance to present their facts," Weitz said. Not to mention, if the charges were dismissed, it would be "open season on late trading" in the mutual fund industry, he added.