Spitzer, OCC Issue Corporate Death Penalty

The news came right before the Thanksgiving holiday, so you might have missed it. But let there be no doubt: The mutual fund investigations have now gone nuclear. New York State Attorney General Eliot Spitzer told a U.S. Senate committee last Tuesday that he wants an entire firm “dissolved” for its role in the mutual fund-hedge fund trading shenanigans. And so does the Comptroller of the Currency,

The news came right before the Thanksgiving holiday, so you might have missed it. But let there be no doubt: The mutual fund investigations have now gone nuclear.

New York State Attorney General Eliot Spitzer told a U.S. Senate committee last Tuesday that he wants an entire firm “dissolved” for its role in the mutual fund-hedge fund trading shenanigans. And so does the Comptroller of the Currency, which is working to shut down the company, Security Trust, by March 31. “It’s unprecedented,” says one industry observer. “I mean, they said, ‘It’s over. You’re done.’ Amazing.”

Spitzer’s office, the SEC and the Comptroller of the Currency, working together, are seeking “an accounting, disgorgement and penalties” from Security Trust and its top executives. In essence, the regulators have declared Security Trust, a mutual fund intermediary based in Phoenix which allegedly made illegal trades on behalf hedge funds, a criminal organization—run by, well, criminals. The firm’s three top executives were charged with larceny, record falsification and fraud.

The regulators slapped Security Trust and its top executives with civil and criminal charges connected to helping hedge funds make “illegal mutual fund” trades. Security Trust is accused of masking those trades through pension plans it controls on behalf of several different hedge funds, including the much-maligned Canary Capital. And then sharing in the profits. According to the SEC, Security Trust brought in approximately $5.8 million from hedge funds through their dealings, namely through a higher custodial fee and a 4 percent profit-sharing plan. Doesn’t sound like much, but the firm is charged with facilitating Canary’s trading in 400 different mutual funds hours after the close, helping the hedge fund reap $85 million in ill-gotten profits.

Some observers believe the regulators are coming down hard on Security Trust because the staid, fiduciary nature of its business magnifies the seriousness of its alleged offenses. Investors view trust firms as bastions of investment safety and conservatism, and in this context, abuses like market timing and late trading for a favored client become even greater betrayals of investor trust than similar abuses at other investment firms.

Security Trust served as custodian for more than 2,500 retirement plans and around $12 billion in retirement assets and is the largest independent trust company. Its role is as a conduit between pension plans and fund companies, and its arrangement with more than 200 fund families gives it access to more than 5,000 different funds. Its relationship with Canary gave that mutual fund the ability to trade after the 4:00 p.m. close using Security Trust’s extensive platform, provided that Security would mask the transactions.

Representatives at Security Trust were unavailable for comment. But the whole story could be summed up in the words of Spitzer, speaking in front of a Senate panel last week: “The company is history.”

Read the SEC’s complaint against Security Trust and its executives here: http://www.sec.gov/litigation/litreleases/lr18479.htm

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