Focus in Fund Scandal Turns to Bear Stearns

Bear Stearns(BSC Quote) is emerging as a critical player in the fast-expanding mutual fund trading investigation, according to sources and court documents.

The big investment bank, which previously reported receiving subpoenas from investigators, is drawing scrutiny from regulators because it processed and cleared trades for a number of small broker-dealers that may have permitted hedge funds to engage in improper trading of mutual funds.

Two brokerages under regulatory scrutiny that used Bear Stearns to process and clear some of their customers' mutual fund trades are Kaplan Securities and Empire Financial Holding, both of Florida.

But beyond clearing and processing trades for mutual fund traders, Bear Stearns might have given traders the tools to carry out those potentially improper transactions, a lawsuit alleges.

A recent lawsuit alleges that Bear created and marketed an "electronic routing system" that made it easier for hedge funds and small brokerages to trade shares of mutual funds. The lawsuit alleges that Bear's trading platform was used to permit hedge funds and brokerages to engage in both market-timing and late trading, the two main offenses regulators are investigating.

The mutual fund trading platform apparently was a lucrative venture for Bear Stearns. The lawsuit contends Bear Stearns "generated substantial revenues and profits from participating in the illegal conduct" of the traders by collecting a commission on each trade executed.

The class-action lawsuit filed in Manhattan federal court specifically alleges that Bear was at the center of much of the improper trading activity that investigators have uncovered in mutual funds sold by Janus(JNS Quote) and Putnam Investments, a division of Marsh & McClennan(MMC Quote).

"We think this is one of the most egregious cases of market-timing and late trading, and documents an incestuous relationships among these players," said Andrew Friedman, an attorney with Bonnett Fairbourn Friedman & Balint in Phoenix. "There is a shocking level of mutual benefits that were reaped by all the defendants to the detriment of the plaintiffs' class."