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Post date: February 3 2004

Banker Charged With Late Trading

Attorney General Spitzer today announced the arrest of a former executive of a leading financial services company for stealing over $1 million from mutual funds by participating in a late-trading scheme. The executive, who is alleged to have arranged financing for the illegal scheme, has also been charged with felony violations of New York's securities laws.

Paul A. Flynn, until recently a Managing Director of Equity Investments at Canadian Imperial Holdings, Inc., a subsidiary of Canadian Imperial Bank of Commerce (CIBC), was arrested today near his Westchester County home. He will be arraigned today in Criminal Court in Manhattan.

In a related action, the United States Securities and Exchange Commission filed civil charges against Flynn.

"Our investigation has demonstrated that it took many players in the industry to make these schemes work," said Attorney General Spitzer. "This is the first case against someone who arranged financing so that late traders and timers could conduct illegal activities. This prosecution sends the message that those who arrange funding for illegal trading will be held accountable, as are those who make the trades."

Flynn has been charged with five felonies, including two counts of Grand Larceny in the First Degree, a Class B felony; two counts of Violation of General Business Law, a Class E felony; and one count of Scheme to Defraud in the First Degree, a class E felony. If convicted of the top count, Flynn faces up to 25 years in state prison.

Flynn, 46, used his position at CIBC to arrange financing for illegal late trading and deceptive market timing of mutual funds by two hedge funds, Samaritan Asset Management (Samaritan) and Canary Capital Partners, LLC (Canary). The charges against him follow an investigation by the Attorney General's Office and the Securities and Exchange Commission.

The hedge funds' trades were placed through Security Trust Company, N.A. (STC), which disguised the hedge fund orders as being those of retirement and pension plans when placing them with mutual funds. The effect of the disguise was to allow the hedge funds to engage both in illegal late trading and in market timing of the mutual funds, and to thwart the mutual funds from enforcing their anti-timing rules. Mutual funds that were illegally traded using Flynn's financing include Massachusetts Financial Services' Emerging Growth Fund and Artisan International Fund.

The complaint alleges that, in furtherance of arranging CIBC's financing, Flynn wrote a memorandum explaining how the scheme works. As to late trading, after noting that trades could be submitted up until midnight, he wrote: "A pricing list is prepared by the company and submitted to our clients who are then able to run their timing models against actual closing prices instead of the previous day before they submit trades. Standard platforms require trades to be into [sic] before 4:00 p.m. submitted by specific account number and broker reference."

As to timing, the complaint quotes Flynn's memo in describing how STC disguised the trades of the hedge funds (CIBC's clients) "to reduce the chance that they would appear to be timing a specific mutual fund."

Mutual fund values are set each day at the 4 p.m. close of the market in New York. In a late trading scheme, however, favored traders are unlawfully allowed to execute trades well after the 4 p.m. cut-off thus illegally profiting from market shaping developments that occur after the close of the market.

"Timing" is an investment technique involving short-term "in and out" trading of mutual fund shares, which has a detrimental effect on the long-term shareholders for whom mutual funds are designed, such as retirees and other "buy and hold" investors. The technique is designed to exploit market inefficiencies when the "net asset value" or "NAV" price of the mutual fund shares – which is set at 4:00 p.m. market close – does not reflect the current market value of the stocks held by the mutual fund. When a "market timer" buys mutual fund shares at the stale NAV, it realizes a profit when it sells those shares the next trading day or thereafter. That profit dilutes the value of shares held by long-term investors.

The Attorney General praised the SEC and its staff for its work on this case. He also thanked CIBC for its cooperation.

The case is being prosecuted by Assistant Attorneys General Ricardo Velez and Charles Caliendo under the supervision of head of the Securities Prosecution Unit Harold Wilson and Chief of the Criminal Prosecutions Bureau Janet Cohn. The case was investigated by Special Investigator Herbert Antomez under the supervision of Chief William Casey.

The charges are merely allegations and the defendant is presumed to be innocent until and unless proven guilty.

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