Under the settlement, Federated Investment Management Company (FIMC), a registered investment adviser, Federated Securities Corp. (FSC), a registered broker-dealer, and Federated Shareholder Services Company (FSSC), formerly a registered transfer agent, have been ordered to give up $27 million in ill-gotten gains and pay a $45 million civil penalty, in addition to $8 million they previously paid to the Federated funds that were harmed by the wrongful conduct. Without admitting or denying the Commission’s findings, the companies also agreed to censures, cease-and-desist orders, and to undertake mutual fund governance and compliance reforms.
“By allowing undisclosed market timing in Federated funds, FIMC disregarded its fiduciary duties to the funds’ long-term shareholders. The Commission will continue to pursue mutual fund advisers, and other fiduciaries, who place their interests above those of fund investors,” said Linda Chatman Thomsen, Director of the Commission’s Division of Enforcement.
“The Commission’s action today demonstrates its ongoing commitment to protecting mutual fund investors from fraud and unfair dealing. By holding the Federated affiliates accountable and imposing strong sanctions for their conduct, we remind mutual fund advisers that they must act at all times in the best interests of fund shareholders,” said Daniel M. Hawke, Associate District Administrator for Enforcement of the Commission’s Philadelphia District Office.
The Commission’s order finds that FIMC, the investment adviser to the Federated funds, and FSC, distributor for the Federated funds, committed securities fraud by approving—but not disclosing to Federated funds shareholders or the funds’ Boards of Trustees—three market timing arrangements, or the associated conflict of interest between FIMC and the funds involved in the arrangements. In addition, FSSC allowed a customer and a Federated employee to late trade.
The Commission’s order finds that, at the time they entered into the market timing arrangements, FIMC and FSC recognized that certain types of market timing could be generally detrimental to certain of the Federated funds and could, among other things, compromise the investment strategies of portfolio managers and increase costs for long-term shareholders. From January 2003 through July 2003, notwithstanding prospectus disclosure and internal procedures designed to prevent market timing, FIMC and FSC provided approved “timing capacity” in certain mutual funds to Canary Capital Partners LLC, a hedge fund managed by Edward J. Stern, and never disclosed this arrangement to other Federated fund shareholders or the Federated funds’ Boards. In return, Canary Capital made a separate investment of non-timed assets, so-called “sticky assets,” in a Federated fund.
At the height of this arrangement, Canary Capital used almost $125 million in timing capacity in six Federated domestic equity funds and invested $10 million in an off-shore Federated fund. FIMC and FSC also entered into undisclosed arrangements with two existing Federated investors to market time high yield bond funds. These two clients used over $18 million and $11 million, respectively, in timing capacity. Both the timed assets and the “sticky assets” produced advisory and other fees for FIMC, FSC and FSSC.
The Commission’s order further finds that FSSC’s mutual fund trade processing system allowed certain FSSC employees to improperly process trades received after 4:00 p.m. at the current day’s net asset value (NAV). Between June and September 2003, a Texas hedge fund executed at least 29 late trades through FSSC. In addition, between July 1998 and March 2003, a former FIMC and FSSC employee, while trading for his own account, entered at least 240 trades after 4:00 p.m. that improperly received the current day’s NAV.
Based on the conduct outlined above, the Commission’s order finds that FIMC willfully violated, and FSC willfully aided and abetted and caused violations of, Sections 206(1) and 206(2) of the Investment Advisers Act of 1940; that FIMC and FSC willfully violated Section 17(d) of the Investment Company Act of 1940 and Rule 17d-1 thereunder; and that FSSC willfully violated Rule 22c-1(a) under the Investment Company Act. The $72 million will be distributed to investors in the funds pursuant to a plan developed an independent distribution consultant.
The Commission’s action has been coordinated with one brought by the Office of the New York Attorney General.
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For further information contact:
Daniel M. Hawke, Associate District Administrator
David S. Horowitz, Assistant District Administrator
Philadelphia District Office
(215) 597-3100
Additional materials: Administrative Proceeding Release No. 34-52839
