The SEC's action was brought contemporaneously with related actions by the New York Attorney General and the Office of the Comptroller of the Currency, with whom the SEC has coordinated its efforts in this matter. The SEC also acknowledges the cooperation of the U.S. Department of Labor, Employee Benefits Security Administration.
Stephen M. Cutler, Director of the SEC's Division of Enforcement, said, "Financial intermediaries who illegally permit their customers to trade mutual fund shares at the expense of long-term investors violate the securities laws and will be held accountable." Cutler added, "Today's important action was a product of swift investigation and effective cooperation by federal and state agencies alike." Randall R. Lee, Regional Director of the SEC's Pacific Regional Office, stated: "Our complaint alleges that for over three years, STC facilitated hundreds of late trades in nearly 400 different mutual funds, to the detriment of the investors in those funds who didn't have the special access to after-hours trading that STC provided. This conduct undermines the fundamental principle that all investors are entitled to equal and fair treatment."
The SEC's complaint charges STC, an uninsured national banking association that, among other services, effects mutual fund trades for participants in retirement plans and processes data regarding those trades for the plans' third party administrators (TPAs); STC's former chief executive officer, Grant D. Seeger, age 40, of Phoenix, Arizona; its former president, William A. Kenyon, age 57, of Phoenix, Arizona; and its former senior vice president for corporate services, Nicole McDermott, age 34, who resides near Phoenix, Arizona.
The SEC's action, filed this morning in United States District Court in Phoenix, alleges the following:
- Late Trading: "Late trading" refers to the practice of placing orders to buy or sell mutual fund shares after market close at 4:00 p.m. EST, but at the mutual fund's net asset value (NAV), or price, determined at the market close. Late trading enables the trader to profit from market events that occur after 4:00 p.m. EST but that are not reflected in that day's price. From May 2000 to July 2003, STC facilitated hundreds of mutual fund trades in nearly 400 different mutual funds by several hedge funds controlled by Edward J. Stern, known as the Canary Capital funds. Approximately 99% of these trades were transmitted to STC after the 4:00 p.m. EST market close; 82% of the trades were sent to STC between 6:00 p.m. and 9:00 p.m. EST. The hedge funds' late trading was effected by STC through its electronic trading platform, which was designed primarily for processing trades by TPAs for retirement plans. At the direction of Seeger and McDermott, STC repeatedly misrepresented to mutual funds that the hedge funds were a retirement plan account, even though STC, Seeger, Kenyon, and McDermott knew that the hedge funds were not a TPA or a retirement plan account. Mutual funds expected that retirement plans and their TPAs required several hours after the market closed to process trades submitted by plan participants before market close. In contrast, the hedge funds had no such business purpose for submitting their own trades as late as five hours after market close.
- Market Timing: "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. During its three-year relationship with the Canary hedge funds, STC and the other defendants employed various methods to attempt to conceal the hedge funds' market timing activities from mutual funds, including the following:
- "Shotgun" method -- STC employees opened accounts for the Canary hedge funds with numerous mutual funds to be traded through STC. The hedge funds then effected trades through these accounts to determine which funds would not detect or actively police timing.
- "Omnibus" method -- STC opened five omnibus accounts for the Canary hedge funds at STC through which the hedge funds' trades were rotated in an attempt to evade detection by the mutual funds.
- "Taxpayer ID" method -- STC opened mirror accounts for the five omnibus accounts using STC's taxpayer identification number. This approach sought to impede efforts by mutual fund companies to detect market timers by their tax ID numbers.
- "Piggybacking" method -- Devised by Seeger and implemented by McDermott, this method involved STC setting up a sub-account within the account of one of STC's TPA clients and attaching the Canary hedge funds' mutual fund trades to the trades of this client without its knowledge. The mutual funds that the hedge funds traded through piggybacking had previously rejected the hedge funds for market timing, and the hedge funds hoped they could continue to trade these funds under the name of another STC client.
STC, Seeger, Kenyon, and McDermott are charged with violating the antifraud provisions of the federal securities laws, Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. STC is also charged with violating Rule 22c-1, promulgated under Section 22(c) of the Investment Company Act of 1940. This provision prohibits the purchase or sale of mutual fund shares except at a price based on the current NAV of such shares that is next calculated after receipt of a buy or sell order. Seeger is also charged with violating Section 37 of the Investment Company Act, which prohibits stealing the assets of a registered investment company. The SEC is seeking an accounting, disgorgement, and penalties from all of the defendants and a judgment of permanent injunction against Seeger, Kenyon, and McDermott.
