Stephen M. Cutler, Director of the SEC's Division of Enforcement, said, "The defendants used a whole host of methods to try to mask their illegal market timing and late trading. These efforts at concealment illustrate the lengths to which the defendants were willing to go to continue enriching themselves at the expense of long-term mutual fund investors."
Harold F. Degenhardt, Jr., District Administrator of the SEC's Fort Worth Office, stated, "The actions of these defendants are but another unfortunate example of the betrayal of mutual fund shareholders and, in this case, their mutual funds. The Commission is committed to rooting out this type of serious misconduct and holding all those responsible fully accountable."
Charged in the SEC's action are -- Mutuals.com, an SEC-registered broker-dealer and investment adviser with 18 institutional and hedge fund clients and the adviser for the Mutuals.com Trust mutual fund (f/k/a 1-800 MUTUALS Advisor Series); Connely Dowd Management, Inc. (CDM) and MTT Fundcorp, Inc. (MTT), two affiliated broker-dealers; Richard Sapio, age 37, of Dallas, Mutuals.com's CEO; Eric McDonald, age 35, of Desoto, Tex., Mutuals.com's president; and Michele Leftwich, age 35, of Dallas, Mutuals.com's compliance officer. The SEC initially detected the alleged misconduct during an examination of the Mutuals.com investment complex in October 2003.
"Market timing" refers to the practice of short term buying and selling of mutual fund shares in order to exploit inefficiencies in mutual fund pricing. Although market timing is not per se illegal, many mutual funds try to prevent it because it tends to harm long-term mutual fund shareholders.
The SEC alleges that, between July 2001 and September 2003, hundreds of mutual fund companies and two clearing firms admonished Mutuals.com that its market timing activities were improper, and, by September 2003, approximately 294 different mutual fund companies had banned or otherwise restricted Mutuals.com from trading in their shares. In response, it is alleged that Sapio, McDonald and Leftwich devised and perpetrated a number of deceptive acts and practices to conceal their clients' market timing activities from those seeking to restrict them.
Specifically, the Commission alleges that, in order to circumvent efforts to restrict their timing activities, Mutuals.com and its principals used a variety of deceptive means, such as (1) formation and registration of two affiliated broker-dealers (CDM and MTT) through which they could continue to market-time undetected; (2) changing account numbers for blocked customer accounts; (3) use of alternative registered representative numbers for registered representatives who were blocked from trading by mutual funds; (4) use of different branch identification numbers; (5) switching clearing firms; and (6) suggesting that their customers use third party tax identification numbers or social security numbers to disguise their identities, so that they could continue to trade in funds from which they had been banned.
"Late trading" refers to the practice of placing orders to buy or sell mutual fund shares after market close at 4:00 ET, but at the net asset value (NAV), or price, determined at the market close. Late trading enables the trader to profit from knowledge of market moving events that occur after 4:00 ET, but are not reflected in that day's fund share price. Late trading is illegal.
With respect to late trading, the SEC charges that, at least during 2003, Mutuals.com and its affiliated broker-dealers routinely received trading instructions from customers after 4:00 p.m. EST and executed those trades as if the trading instructions had been received prior to that closing time. According to the SEC, Mutuals.com and its affiliates attempted to conceal late trading activities by omitting portions of the trading information that they were required to provide to clearing agents.
In its action, the SEC is seeking permanent injunctions from further securities law violations, civil money penalties and disgorgement of illicit profits plus prejudgment interest. At the SEC's insistence, the defendants have agreed to a Court-appointed Special Monitor for Mutuals.com, to oversee management of the Mutuals.com Trust mutual fund (1-800 MUTUALS Advisor Series), pending the resolution of the civil litigation.
The Commission's investigation is continuing.
