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Focus in Fund Scandal Turns to Bear Stearns

The lawsuit also contends Empire Financial used the Bear Stearns trading platform to transmit its customers' mutual fund trades. Empire officials didn't return several telephone calls.

Empire Financial, which operates a small online brokerage business, said last week that the SEC served a subpoena on the company and on four employees in connection with the mutual fund trading investigation. Empire previously has said that Canary Capital was one of its mutual fund customers but that all of the hedge fund's trades were proper.

A person familiar with the investigation said Millennium also was a customer of Empire Financial. Another person familiar with Empire Financial said it had similar mutual fund trading arrangements with a number of hedge funds and that those deals were a profitable business for the firm.

Besides Bear Stearns, the lawsuit also names Canary, Millennium, Empire Financial, Janus and Putnam as defendants. The lawsuit was filed by lawyers on behalf of Michael Pflugrath, an investor in several Janus and Putnam funds.

The lawsuit alleges that Bear Stearns' trading platform made it particularly easy for hedge funds and brokers to engage in late trading in shares of mutual funds. In some instances, customers were able to enter orders to buy stocks up until 8 p.m. ET, well after the 4 p.m. close of trading. The trading platform was also used to cancel buy orders, so customers could wait to assess the impact of some late-breaking news on the market.

Late trading has emerged as one of the most serious offenses prosecutors and regulators are examining in the quickly expanding investigation into the $7 trillion mutual fund industry. But it's possible Bear Stearns and its brokerage customers could have a valid defense to some of the allegations in the lawsuit.

That's because the issue of what constitutes late trading is not as clear-cut as it's been made out to be. In fact, has previously reported that a number of high-powered lawyers have written legal opinions for their brokerage clients saying the regulation that's supposed to bar late trading may actually permit some trades to take place up until 5:30 p.m. -- 90 minutes after the markets have closed.

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