Regulators are not just targeting those in cahoots with market timers. Now, any firm that failed to do enough to keep the wolves out of the pen is fair game.
Negligence is no excuse for the law, according to the NASD, which has just fined State Street Research (SSR), a unit of MetLife, $1 million and required the company to pay shareholders restitution of $533,000. The firm was not charged with arranging market-timing agreements with preferred clients in exchange for the fees it would collect for managing those dollars, such as was the case with MFS.
Rather, the NASD claims State Street had inadequate supervisory systems in place, which allowed timers to circumvent the rules and harm long-term shareholders.
Many lawyers and those in the industry expect to see an increasing number of cases similar to State Street's, with internal-control violations and back-office activity being central to those probes. "We're looking at a number of timing cases," said Nancy A. Condon, a spokeswoman for the NASD, adding "we can't bring criminal charges, though." Condon declined to quantify just how many similar cases the agency is working on.
While the more than $1.5 million may seem like chump change to major financial institutions, the thought of having regulators poke their noses into every corner of a firm's business is surely not an attractive proposition.
"As a practical matter, both federal securities laws and the NASD require you to have systems of supervision and compliance that prevent potential violations of the law," said Nancy Van Sant. Van Sant is a partner at Miami-based Sacher, Zelman, Van Sant, et al, and the former regional trial counsel for the SEC's Atlanta regional office. She said that the low price tag of the fine, which was "not a big deal," likely correlated to the amount of damage done to shareholders and that there are guidelines that regulators generally follow when determining the amount of a fine.
However, ignorance is not always bliss, she said. "Intentional conspiratorial violations are the worst, but negligent inaction hurts fund investors as well."
Not Just About the Money
The NASD has also required that SSR disclose all instances of mutual fund exchanges that exceed limits outlined in the prospectuses. "For this particular situation, their review spans from 2001 to August of 2003," said Robyn Tice, a spokeswoman for SSR. "It involved less than 130 shareholder accounts, out of a base of more than 800,000 shareholder accounts," Tice said. In addition to the fine and restitution, SSR is required to certify that it has put in appropriate market-timing systems and controls.
Tice said the firm received no specific recommendations from the NASD on how to improve its systems, but that over the course of the last several years, SSR has been enhancing its trade supervision, reporting and monitoring - and just trying to give its employees more tools to deal with the changing environment. "There is no real exact science on how to monitor," Tice said. "We just spent a lot of time enhancing reporting capabilities. We are much more systematic. There's not a comprehensive automated way to do it." The headcount of that unit has not increased, either, fluctuating between six and eight staffers, Tice said
Foxes in the Hen House
Timers were able to get around stopgaps the firm had in place, due to its inadequate supervision and systems, the NASD said. Because of these shortcomings, between 2001 and August 2003, at least one firm, Prudential Equity Group, formerly Prudential Securities, was able to market time SSR funds.
To attempt to prevent timing in its funds, SSR had typically limited exchanges in and out of a fund to six times per year. According to the NASD, SSR had knowledge that Boston-based Prudential employees were using deceptive methods in order to time its funds. To get around the rules, Prudential's registered reps would use more than one account for the same client to circumvent "block letters," which barred an investor from making any further trades in an account because he or she had already reached the exchange limit specified in the prospectus.
In its complaint, the NASD maintained that SSR "personnel had reason to know that certain registered representatives, after receiving block letters, had transferred customer money to new accounts and continued to execute exchange transactions." However, the NASD also said it found that SSR's systems were not able to detect customers circumventing the blocks. The procedures in place were not set up to follow up on those block letters appropriately.
"Market timing, in violation of prospectus limits, can dilute the value of fund shares, raise transaction costs and thus harm other fund shareholders," said Mary L. Schapiro, vice chairman of NASD, in a statement. "When a firm is on notice, as SSR was, that its funds are being timed, the firm must respond quickly and effectively."
Blocks were not always set up quickly enough, the regulatory agency claims, as customers had already passed the exchange limit before they were sent a block letter, in some cases. Additionally, the firm failed to keep e-mails relating to its business, as required by federal law.
The NASD said the fine and restitution promise resolves the matter with SSR, but it is continuing to investigate conduct relating to the case and other market-timing violations. For its part, State Street is satisfied with the resolution, Tice said. "They're done here," she said.
As for the SEC, Tice said the regulatory body is aware of the allegations relating to the NASD settlement, but the firm doesn't expect further disciplinary action.
Copyright 2004 Thomson Media Inc. All Rights Reserved.
http://www.thomsonmedia.com http://www.mmexecutive.com
