More Are Questioned in Bear Stearns Probe

Investigators want to know who knew what in the company's sprawling clearing operation.
By Matthew Goldstein ,

Federal regulators are stepping up their inquiry into

Bear Stearns'

(BSC)

role in the mutual fund trading scandal, sources familiar with the inquiry said.

In recent weeks, attorneys for the

Securities and Exchange Commission

have been questioning people about Bear Stearns' role in clearing and processing trades for a number of small brokerage firms that may have permitted hedge funds to engage in improper trading of mutual funds.

Sources said regulators are interested in what managers in Bear Stearns' clearing division knew about any improper trading. In particular, regulators are trying to learn whether officials at the big Wall Street firm were aware that some brokers might have used deceptive measures -- such as multiple accounts and false identities -- to help their clients engage in improper trading.

One defense attorney who is familiar with the investigation but didn't want to be identified said that if there was any wrongdoing, "there's no way that Bear Stearns could not have known what was going on."

An SEC official declined to comment. Bear Stearns' outside attorney, Lewis Liman, a partner at Cleary Gottlieb Steen & Hamilton and a former federal prosecutor, also would not comment on the progress of the investigation.

In November,

TheStreet.com

first reported that securities regulators, along with federal prosecutors in New York, were closely scrutinizing Bear Stearns' role in the trading scandal. The firm's trade-clearing operation is one of the largest on Wall Street.

Small brokerages often rely on big clearing firms such as Bear Stearns to handle the back-office function of processing customer trades and serving as a custodian for their customers' accounts, because the operation is costly and capital-intensive.

In fact, Bear Stearns' clearing arm processed mutual fund trades for several small brokerages that have garnered their own regulatory scrutiny, including

Brean Murray

,

Empire Financial

(EFH)

and

Kaplan Securities

. Officials at all three firms declined to comment.

Additionally, a lawsuit filed in New York federal court has alleged that Bear Stearns' clearing outfit developed a trading platform that made it easier for hedge funds and small brokerages to engage in market-timing and late trading -- the two main offenses regulators are investigating.

Market-timing is the term for a shady strategy in which mutual fund shares are bought and sold frequently in order to profit from price differences in different markets. It's harmful for the vast majority of mutual fund investors, because it can dilute the value of a fund by driving up trading and administrative costs.

Late trading is an even more serious offense. It means a mutual fund company permits a favored customer to buy shares that were priced prior to the release of market-moving news, giving the investors an unfair advantage.

It's too soon to say whether regulators will be able to hold Bear Stearns liable for any infractions committed by its brokerage customers. Clearing is often seen as an administrative task, and firms that do clearing work are generally held to a lower standard of due diligence than the brokerages they process trades for.

However, courts have been more willing to hold clearing firms to a higher standard of liability, ever since Bear Stearns paid a $38.5 million fine in 1999 to settle an SEC investigation into the firm's role in clearing and processing trades for A.R. Baron, a corrupt brokerage firm.

Late last year, the SEC signaled that clearing firms again might not walk away scot-free in the mutual fund trading probe, either. In November, regulators notified

J.B. Oxford

(JBOH)

that the firm was facing a possible enforcement action for its role in clearing and processing trades for several brokerage firms that may have engaged in improper trading of mutual fund shares.

J.B. Oxford, a small Los Angeles-based firm best known for its online brokerage division, generates roughly 18% of its $19 million in annual revenue from providing clearing services. The firm, in regulatory filings, has said it could face "substantial penalties" if the SEC decides to bring an action against it.

At Bear Stearns, the clearing business accounted for $784 million, or 13%, of the firm's $6 billion in net revenue in 2003.

Last September, New York Attorney General Eliot Spitzer alleged that J.B. Oxford processed some illegal mutual fund trades for

Canary Capital Partners

. Spitzer's $40 million settlement with Canary launched the sprawling investigation of the mutual fund industry.

Loading ...