Updated from 10:58 a.m. EDT
Bank of America
broker on Tuesday became the first securities industry employee to face criminal charges in the widening government investigation into illegal trading in mutual fund shares.
New York Attorney General Eliot Spitzer announced the filing of criminal charges against Theodore Sihpol at a joint news conference with
Securities and Exchange Commission
chief of enforcement Stephen Cutler. The SEC, which is now working with Spitzer's office in the investigation, filed a civil complaint against the 36-year-old Connecticut resident.
The nation's third-largest bank last week fired Sihpol, along with several other employees who have been implicated in the trading scandal. One of the allegations is that BofA permitted a hedge fund to make "late trades" of mutual fund shares, an illegal practice.
Sihpol is expected to be arraigned Tuesday afternoon in New York City Criminal Court on larceny and securities fraud charges. Sihpol's lawyer, Donald Buchwald, said his intends to plead innocent. If convicted, he could be sentenced to serve up to 25 years in jail.
The criminal case against Sihpol is one of the first to be brought against a Wall Street banker in the many corporate scandals of the past few years. No criminal charges were filed against analysts or investment bankers in last year's tainted research investigation, which was started by Spitzer's office and culminated this spring with 10 Wall Street firms paying $1.4 billion in fines and restitution.
The filing of criminal charges against Sihpol comes two weeks after Spitzer shocked Wall Street by announcing that his office had found at least four mutual fund families had allowed illegal trading by a New Jersey hedge fund,
Canary Capital Partners
. The funds include ones offered by Bank of America's Nations Funds,
Spitzer, who settled the investigation against Canary by imposing a $40 million fine on the hedge fund, hinted his office might pursue criminal charges against some of the bankers involved in the trading schemes. On Tuesday, he reiterated that the investigation is far from over.
"It's likely to result in numerous other charges,'' said Spitzer, who declined to say how many hedge funds and mutual funds had been served with subpoenas as part of the inquiry.
Spitzer and Cutler also took turns at the press conference to say that they are working together in the investigation. The show of cooperation by the two government agencies comes after many securities lawyers had faulted the SEC for being asleep at the switch and getting outfoxed again by Spitzer's office in pursing a high-profile case.
For much of this year the mutual fund has been under fire from a variety of state and federal regulators.
The SEC's Philadelphia office is overseeing an investigation into
mutual fund business over allegations its brokers steer customers into more costly mutual fund products. The commission also is conducting a broader inquiry into the level of disclosure fund families provide customers about fees and hidden costs.
Officials in Massachusetts are looking into potential illegal trading activities involving mutual funds sold by
, a joint venture between
. On Tuesday, Massachusetts Secretary of State William Galvin said his office had expanded his inquiry to include
The NASD joined the party Tuesday when it fined Morgan Stanley $2 million for organizing contests that rewarded brokers and managers who sold the most mutual fund shares. Securities regulations bar such contests because it might encourage brokers to make sales that are not in the best interest of their customers.
Despite the industry prohibitions on such contests, the NASD said that from October 1999 to December 2002, Morgan Stanley conducted 29 of them. The winners got tickets to Britney Spears and Rolling Stones concerts and the NBA finals.
But the inquiry launched by Spitzer's office appears the most serious as it's the first to result in the filing of criminal charges.
Spitzer's office has alleged that all four mutual funds permitted Canary to engage in market timing, an arbitrage strategy that allows savvy traders to take advantage of the time differences between the closing of the U.S. markets and foreign exchanges. While the fast, in-and-out trading that market timers engage in is legal, most mutual funds try to discourage it because it can dilute the value of a fund by causing unnecessary trading costs.
BofA's Nations Fund is accused of the most serious transgression, allegedly enabling Canary to purchase shares in a mutual fund after the close of the trading, but at their 4 p.m. EDT price. This is a practice called "late trading," and it's an absolute no-no in the industry.
Normally, mutual fund shares are priced once a day, after the fund calculates its net asset value. Orders to buy or sell shares that are submitted after the 4 p.m. close are supposed to be processed at the next day's prices. But Nations Funds enabled Canary to trade well after the 4 p.m. and close, yet take advantage of the old prices.
The criminal charges against Sihpol stemmed from his role in enabling Canary to engage in late trades.
Sihpol was a central figure in the trading scandal because he helped land Canary, whose managing partner is Edward Stern, as a BofA client. One memorandum prepared by Sihpol speculates just how valuable Canary's business could be to the bank, noting that the Stern family has a net worth of $3 billion and is the 11th-richest in the New York City area. He persuaded BofA to install a computer system at Canary's office that helped them with their late-day trading.
Sihpol was cut loose by Bank of America last week along with two other employees implicated in the trading scandal. BofA also ousted Charles Bryceland, a branch manager for Banc of America Securities and one of Sihpol's supervisors, and Robert Gordon, co-president of Banc of America Capital Management.
Eloise Hale, a BofA spokesman, said the bank is cooperating with the investigations.
The criminal complaint filed by Spitzer's office makes clear that his office had lots of help in its investigation from Stern, who has agreed not to trade shares of mutual funds for the next 10 years as part of his settlement. Investigators also got help from Andrew Goodwin, a former trader at the hedge fund.
Stern is the son of Leonard Stern, chairman of
Hartz Mountain Industries
, a New Jersey-based real estate company, and former publisher of the
. The Stern family originally built its fortune from selling pet products. The patriarch of the family business was Max Stern, Edward's grandfather, who emigrated to the U.S. from Germany in 1926, carrying 5,000 singing canaries with him.