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November 28 2005
Federated Settles Mutual Fund Timing Investigation
Attorney General Spitzer today announced an agreement with Federated Investors, Inc. to resolve an investigation of improper trading of mutual funds.
The settlement with the Pittsburgh-based company was reached in conjunction with the Securities and Exchange Commission and announced simultaneously today.
"Federated worked with regulators to address problems with improper trading," Spitzer said.
"With this agreement, virtually the entire mutual fund industry has now sworn off improper trading practices and agreed to compensate investors who were harmed."
Federated is the 14th firm to settle improper mutual fund trading charges since the Attorney General announced a landmark case against Canary Capital Partners in September 2003. To date, the investigations emanating from the Canary case have returned approximately $3.3 billion to investors. In addition, nine mutual fund executives have pleaded guilty to fraud and related charges.
Under the latest agreement, Federated will pay a total of $35 million in restitution to injured investors and $45 million in civil penalties, and will reduce its management fees by an estimated $20 million over the next five years. The $35 million payment includes $8 million already paid by Federated as restitution to certain Federated funds. Federated has further agreed to substantial reforms including the hiring of a full-time senior officer to help ensure that advisory fees charged for managing the funds are negotiated at arm’s length and are reasonable.
The investigation of the company centered around mutual fund timing, which involves the frequent buying and selling of mutual funds. Such trading can harm long term mutual fund shareholders by diluting the value of their shares.
In breach of its fiduciary obligations, Federated entered into secret "market timing" arrangements with three professional trading organizations knowing that these arrangements would negatively impact the investment returns of ordinary mutual fund shareholders. Federated also tolerated a substantial amount of harmful transactions by market timers with which it had no express arrangement. Federated had an incentive to allow these frequent trading activities because it earned substantial investment advisory fees on the fund timers’ assets.
In one secret deal, Federated permitted Canary to conduct frequent trading of six different Federated domestic equity funds. Canary ultimately conducted more than $1.6 billion in timing transactions in Federated funds. In exchange for the right to make these timed trades, Canary made a so-called "sticky money" investment of $10 million in a Federated-advised fund on which Federated earned additional fees.
The investigation further revealed that another hedge fund illegally placed orders directly with Federated after the 4:00 p.m. EST close of the financial markets, and yet still received that day’s price. By law, mutual fund orders must be received before the close of the market to receive that day’s price.
The investigation was handled by Assistant Attorney General Charles Caliendo with assistance provided by Economist Hampton Finer of the AG’s Public Advocacy Division.
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