Linda Chatman Thomsen, Director of the SEC's Division of Enforcement, said, "By knowingly financing customers' late trading and market timing, as well as providing financing in amounts far greater than the law allows, CIHI and World Markets boosted their customers' trading profits at the expense of long term mutual fund shareholders. This settlement will help compensate victims and prevent similar violations from happening in the future."
Mark K. Schonfeld, Regional Director of the Northeast Regional Office, added, "CIHI's swap transactions were little more than sham loans designed to evade the margin regulations. Today's Order demonstrates that financial institutions cannot use structured transactions to flout the law."
The Commission's Order finds that, CIHI and World Markets engaged in three types of conduct that violated the federal securities laws: a) CIHI financed hedge fund customers while knowing the hedge funds would use the leverage to late trade and deceptively market time mutual funds; b) CIHI provided, and World Markets arranged, improper financing for market timing hedge fund customers in violation of the margin and extension of credit requirements; and c) a team of World Markets registered representatives (RRs) enabled numerous customers to late trade and deceptively market time mutual funds.
With respect to the financing, the Order finds that CIHI provided funds to at least two hedge fund customers knowing those hedge funds would use the leverage to late trade and market time. By leveraging these entities while knowing they were engaged in deceptive market timing and late trading, CIHI participated in a scheme to defraud mutual funds and their long term shareholders, thus violating the antifraud provisions of the federal securities laws.
The Order also finds that CIHI violated the margin regulations. CIHI financed market timing hedge funds through loans secured by mutual fund shares. These loans were improperly characterized as total return swaps. Through these loans, CIHI extended credit on the mutual fund shares in amounts beyond what the margin regulations allow. By doing so, CIHI violated the margin regulations. In addition, because World Markets helped arrange for this financing, it also violated these provisions.
Finally, the Order finds that from at least 1999 until January 2003, World Markets engaged in widespread deceptive market timing and late trading through a team of RRs who used, among other tactics, multiple accounts, multiple RR numbers, and small trade size broken up across related accounts to deceive mutual funds and "stay under the radar" of the mutual funds' internal timing monitors. Senior World Markets officials knew about this team of RRs' deceptive market timing activities and took steps to assist them, ensuring that this team of significant business producers could continue to facilitate market timing. In addition, some of these RRs knowingly accepted numerous mutual fund orders from at least one of their timing customers after 4:00 p.m. ET, and processed those orders as though the customer had placed the order prior to 4:00 p.m. ET.
As a result, the Commission's Order finds that CIHI willfully violated Section 17(a) of the Securities Act of 1933, Sections 7(d) and 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, Regulation U promulgated by the Federal Reserve Board regarding the extension of margin credit, and willfully aided and abetted and caused violations of Rule 22c-1, as adopted under Section 22(c) of the Investment Company Act of 1940. The Commission's Order further finds that World Markets willfully violated Section 17(a) of the Securities Act, Sections 7(c), 10(b), 11(d), 15(c) and 17(a) of the Exchange Act and Rules 10b-3, 10b-5, and 17a-3 thereunder, Rule 22c-1, as adopted under Section 22(c) of the Investment Company Act of 1940, and Regulation T promulgated by the Federal Reserve Board regarding the extension of margin credit.
CIHI and World Markets consented to the entry of the Commission's Order without admitting or denying the Commission's findings.
In determining to accept the settlement, the Commission considered CIHI's and World Markets' cooperation in this investigation.
The SEC's action was brought contemporaneously with a related action by the Attorney General of the State of New York.
The Commission's investigation is continuing.
Additional materials: Administrative Proceedings 33-8592 and 33-8593.
