Fremont Fined $4.1M for Timing, Late Trades
November 8, 2004
Market-timing woes continue to pervade the mutual fund industry, as even smaller shops are getting caught in the act.
Fremont Investment Advisors (FIA) on Thursday agreed to a $4.146 million settlement with state and federal regulators over allegations that the company allowed preferred clients to engage in inappropriate market-timing and illegal late-trading of its mutual funds. The San Francisco-based firm manages 12 mutual funds with a total of $3 billion in assets under management, which illustrates a new wrinkle to the scandal in that most of the firms that have been involved thus far have been large fund complexes.
"This is a disturbing indicator that the abuses we have seen in the industry extended even to smaller, regional firms," said Marc Fagel, assistant district administrator of the SEC's San Francisco district office.
Under the terms of the settlement, FIA must pay a $2 million fine along with $2.146 million in restitution and disgorgement to those investors harmed by the illicit trades. In addition, Nancy Tengler former president, director and chief investment officer of Fremont, was fined $127,000 for approving the market-timing scheme. Larry Adams, former vice president of institutional sales, was also charged in the timing suit for negotiating several timing arrangements. A separate hearing has been scheduled for Adams to determine the validity of the allegations against him.
"The lesson from this long-running investigation is that you must not have one set of rules for privileged insiders and another set for everyday investors," said New York Attorney General Eliot Spitzer. "The mutual fund industry will only regain the public's trust when it treats everyone fairly and with respect."
The complaint alleges that Fremont entered into undisclosed arrangements in 2001 and 2002 allowing certain large investors to gouge long-term shareholders by trading rapidly in and out of the Fremont Global Fund and the U.S. Micro-Cap Fund. In October 2001, Fremont entered into a written market-timing agreement with brokerage Brean Murray that allowed one of the broker's clients, hedge fund Canary Capital Partners, to time the U.S. Micro-Cap Fund in return for a $10 million investment in a newly launched Fremont fund co-managed by Tengler, who was the CEO at the time.
A Lucrative Setup
Adams engineered the plan, which once approved by Tengler, proved to be a very lucrative setup for Fremont. From October 2001 to October 2002, Canary made 20 exchanges between the U.S. Micro-Cap Fund and Fremont's money market fund, far exceeding the limits laid out in the prospectus.
Each exchange varied from $13 million to $17 million and totaled more than $600 million over a year's time. All told, the Canary trades generated $104,000 in advisory fees while its $3.7 million sticky investment -- not the $10 million it initially promised -- generated an additional $27,000 in fees. Fund shareholders were kept completely in the dark about the under-the-table affair.
In fact, the prospectus explicitly told fund shareholders: "Fremont does not permit excessive short-term trading, market-timing, or other abusive trading practices in our funds. These practices may disrupt portfolio management strategies and harm fund performance. Fremont defines abusive trading practices as making six or more complete exchanges into and out of one fund within a 12-month period."
Even more disturbing was that at the same time loopholes were being made for preferred customers, other shareholders who made six or more complete exchanges in a year were issued a notice that their trading privileges were being revoked. "Excessive and unpredictable trading hinders a fund manager's ability to pursue the fund's long-term goals," the letter said.
In addition to the market-timing transgressions, and certainly more egregious, was that one of its employees allowed a brokerage firm to place trades in two Fremont funds after the 4 p.m. close for three of its customers while still benefiting from the current day's price. From June 2001 to September 2001, the undisclosed brokerage firm placed more than 50 trades after the closing bell. There was no attempt to determine whether the trades were submitted prior to the close as required by trading rules. The employee, who was not named in the complaint, was subsequently given a pink slip.
Fremont CEO E. Douglas Taylor issued a statement saying that the company is "committed to upholding the funds' policies to prevent market timing and late trading." He also said that Fremont conducted a "wide-ranging investigation" into trading improprieties and that the probe found that each of the timers named in the settlements had an "aggregate net loss" from its trading activities. Additionally, the internal probe found that no portfolio managers were involved in timing their own funds.
In an effort to prevent future transgressions, Fremont has implemented a number of reforms, including a written policy that outlines the process by which timers are identified and blocked, a certification attesting to their review and a "whistleblower protection policy." The whistleblower provision will create a direct reporting line to the chief legal officer or the lead independent director for any employee who uncovers trading misconduct or potential securities violations.
With the scandal behind it, FIA can now move forward with the previously approved sale of the Fremont Funds to Affiliate Managers Group, an agreement reached in July. The deal is expected to close within the next few months.