The two-year-old mutual fund trading investigation notched another kill Monday when
agreed to a $72 million settlement of charges that it helped facilitate unethical trading strategies in its funds.
The settlement comprises the disgorgement of $27 million in ill-gotten gains and a $45 million civil penalty. Federated said in November 2003 that it had
discovered both market-timing and late-trading in its funds during an internal investigation.
Two Federated affiliates, Federated Investment Co. and Federated Securities Corp., were accused of cutting a market-timing deal with the hedge fund at the center of the scandal, Canary Capital Partners. According to a
Securities and Exchange Commission
complaint, Federated let Canary execute the arbitrage strategy in several funds without disclosing it to other shareholders.
The undisclosed facilitation of market timing, which uses rapid-fire trades to capitalize on pricing discrepancies in mutual funds, has led to more than $3 billion in fines and disgorgements from mutual fund companies and other firms since the practice was targeted by New York Attorney General Eliot Spitzer in the fall of 2003.
"At the height of this arrangement, Canary Capital used almost $125 million in timing capacity in six Federated domestic equity funds and invested $10 million in an off-shore Federated fund," the SEC said. In return, Federated collected commissions on the trading and also got Canary to invest long-term assets in another Federated fund.
According to the complaint, the two Federated affiliates also had arrangements with two existing Federated investors to market-time high-yield bond funds. These two clients used over $18 million and $11 million, respectively, in timing capacity, the SEC said.
Meanwhile, a third Federated affiliate, Federated Shareholder Services Corp., was alleged to improperly have allowed various employees and a Texas hedge fund to make late trades over its processing system. In late trading, someone uses breaking news to make a sure-thing bet on a mutual fund whose price is stale.