Pursuant to the Order, Bear Stearns will pay $250 million, consisting of $160 million in disgorgement and a $90 million penalty. The money will be paid into a Fair Fund to be distributed to the harmed mutual funds and mutual fund shareholders. Bear Stearns will also undertake significant reforms to improve its compliance structure. Simultaneously, NYSE Regulation, Inc. censured and fined Bear Stearns, and imposed compliance with these undertakings. The fine imposed by the NYSE will be deemed satisfied by the payment of the $250 million pursuant to the Commission's Order.
Linda Chatman Thomsen, SEC Enforcement Division Director, said, "For years, Bear Stearns helped favored hedge fund customers evade the systems and rules designed to protect long-term mutual fund investors from the harm of market timing and late trading. As a result, market timers profited while long term investors lost. This settlement will not only deprive Bear Stearns of the gains it reaped by its conduct, but also require Bear Stearns to put in place procedures to prevent similar misconduct from recurring."
Mark K. Schonfeld, Director of the Northeast Regional Office, said, "Bear Stearns was the hub that connected the many spokes of market timing and late trading - hedge funds, brokers and the mutual funds. Tape-recorded phone calls of its employees make plain the two roles played by Bear Stearns that were fundamental to mutual fund trading abuses. Bear Stearns made it possible for hedge funds and brokers to submit orders long after the 4:00 p.m. cut-off. Bear Stearns made it easier for the hedge funds and the brokers to engage in market timing, and harder for the mutual funds to detect and stop it."
Bear Stearns' Timing Desk
BS&Co. is an introducing broker dealer whose customers buy and sell securities. BSSC is a clearing firm for BS&Co., other introducing broker dealers and prime brokerage customers (i.e., hedge funds that clear trades directly through BSSC). From 1999 through September 2003, Bear Stearns facilitated late trading and deceptive market timing of mutual funds by its customers and customers of BSSC's introducing broker dealers. BSSC cleared all these unlawful mutual fund trades through its Mutual Fund Operations Department (MFOD).
In 1999, BSSC established a "timing desk" to manage the increasing flow of market timing trades through BSSC. The timing desk assisted customers to enter late trades and even to cancel unprofitable trades the following day. The timing desk also advised customers and brokers on how to evade the blocks and restrictions imposed by the mutual funds and how to negotiate BSSC's own blocking system. Some market timers expressed their appreciation for this assistance by giving timing desk employees gifts such as spa gift certificates, event tickets and meals.
Late Trading
Bear Stearns facilitated late trading. At BS&Co., certain brokers actively facilitated late trading by knowingly processing a large number of late trades for certain of their market timing customers. In some cases, BS&Co. brokers and MFOD employees falsified order tickets by recording that orders which were actually received after 4:00 p.m. had been received at 3:59 p.m. or 4:00 p.m. In a tape-recorded telephone call, an MFOD supervisor advised a BS&Co. broker:
Because you're sending trades down some days after what's considered a legitimate time, 4 o'clock New York time, we want, we want to make sure that you know that we need to populate a time prior to 4:00 p.m. New York time. What I'd like for you to do, we're going to populate either 4:00 p.m. or 3:59. … [Y]ou know, obviously, you should have them before 4 … Obviously, we aren't going to receive it most of the time before four, but it has to be written - the written time has to be before 4:00 p.m. New York time, so that if the auditors come to us, and, you know, they want to see something, we have that you took, you took the trade before 4:00 p.m.
On the clearing side, BSSC gave introducing brokers and prime brokerage customers with mutual fund trading business direct access to its mutual fund order entry system. This system permitted users to enter orders until 5:45 p.m. and processed all trades, regardless of when they were actually received, as if they had been received before 4:00 p.m. The effect, in the case of prime brokerage customers, was to put the order entry system directly in the hands of the ultimate customer who then used the system to trade at will without an intermediary broker. Thus, using the platform provided to them by Bear Stearns, certain prime brokerage customers had the ability to - and did - engage in unchecked late trading. BSSC also knowingly facilitated late trading by certain introducing broker dealers. In fact, BSSC assured at least two of its introducing brokers with significant market timing business that Bear Stearns would be able to accommodate their late trades.
In some cases, BSSC employees touted BSSC's abilities to assist timers - including the fact that BSSC's mutual fund order entry system permitted entry of orders after 4:00 p.m. - to potential market timing customers. In a tape-recorded telephone conversation, an MFOD supervisor stated to a well-known market timing broker who was being recruited by BS&Co., "Well, just to let you know - just to get you aboard - we probably do the best clearance there is on the Street on market timing…." Then, in response to a direct question by the broker about the cut-off time for trades, the MFOD supervisor responded, "You have plenty of time to do trades . . . pretty much a quarter to six, 5:45 to enter a trade."
Deceptive Market Timing
Bear Stearns also helped its market timing customers evade detection by mutual funds that did not want market timing business. Upon detecting market timing trades, mutual funds often blocked further trading by market timers by reference to the available identifying information accompanying the trade, such as the account number, registered representative (RR) number or branch code. To evade these blocks, BS&Co. helped its market timing customers hide their identities from mutual funds by, for example, assigning multiple account numbers to customers so that the mutual funds could not identify them as customers whose trades the mutual funds had previously blocked, or by assigning multiple RR numbers to registered representatives at BS&Co. to conceal the identity of the traders.
BSSC likewise facilitated deceptive market timing by its prime brokerage customers and customers of its introducing brokers by providing them with deceptive devices, such as multiple account and RR numbers and alternative branch codes, to help them avoid detection by mutual funds. In an email, a BSSC manager explained the strategy:
many of the funds don't want market timers and bear stearns simply relays the message to the customer.some ways in which we have "addressed" this to keep the customer happy is to change the rr number on the trades or to open additional acct numbers in the family since the mf companies target certain office ranges and rr #'s and classify them as timers.
Between 1999 and 2003, BSSC received thousands of letters or emails from mutual funds complaining about abusive trading or requesting that timing be stopped. In response to these complaints and stop notices, BSSC developed a system that was supposed to stop unwanted market timing. BSSC touted the blocking system to mutual funds. In reality, however, the system was designed to stop only the specific account that had been identified by a particular mutual fund as an unwanted market timer from trading in that fund. Thus, this system permitted the same timer to continue timing the same mutual fund simply by opening new accounts. Bear Stearns then assisted with the opening of the new accounts that were necessary for these customers to continue their unwanted mutual fund trading. Only if a mutual fund threatened to terminate its dealer agreement with Bear Stearns would Bear Stearns put a stop to all market timing in that mutual fund.
As a result of this conduct, the Order finds that: (1) BSSC willfully violated, willfully aided and abetted, and caused violations of Section 17(a) of the Securities Act of 1933; (2) BS&Co. willfully violated, willfully aided and abetted, and caused violations of Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; (3) BS&Co. and BSSC willfully violated, willfully aided and abetted, and caused violations of Section 15(c) of the Exchange Act and Rule 15c1-2 thereunder; (4) BSSC willfully violated Rule 22c-1(a) as adopted under Section 22(c) of the Investment Company Act of 1940; (5) BS&Co. willfully aided and abetted, and caused BSSC's violations of Rule 22c-1(a) as adopted under Section 22(c) of the Investment Company Act of 1940; and (6) BS&Co. and BSSC willfully violated, willfully aided and abetted, and caused violations of Section 17(a) of the Exchange Act and Rule 17a-3(a)(6) thereunder.
Pursuant to the Order, in which Bear Stearns neither admits nor denies the findings, Bear Stearns will pay $250 million consisting of $160 million in disgorgement and a $90 million civil penalty. The money will be paid into a Fair Fund to be distributed according to a plan to be developed by an independent distribution consultant. Bear Stearns has agreed to significant remedial undertakings designed to improve its compliance structure. The remedial actions include the retention of an independent compliance consultant to conduct a comprehensive review of BSSC's policies and procedures related to compliance and supervision in the areas of prime brokerage and correspondent clearing, and a review of BS&Co.'s policies and procedures in the area of mutual fund transactions. BSSC has agreed to maintain a Director of Compliance and establish an Internal Compliance Controls Committee, both of whom will report to a committee of The Bear Stearns Companies Board of Directors. BSSC will also provide training and education to its employees designed to minimize the possibility of future violations of the federal securities laws or New York Stock Exchange and NASD rules. Finally, Bear Stearns will establish a Compliance Hotline where employees can anonymously obtain answers to questions or report conduct that may be a cause for concern.
The Order censures BS&Co. and BSSC and directs them to cease and desist from committing or causing violations or future violations of the preceding provisions of the federal securities laws.
In determining to accept the settlement, the Commission considered the remedial acts undertaken by Bear Stearns and the cooperation afforded the Commission staff.
The Commission's investigation is continuing.
The Commission acknowledges the assistance provided by the New York Stock Exchange.
