The founding partners of

Pilgrim Baxter & Associates

have resigned after the firm discovered that one of them was an investor in a hedge fund that "actively" traded Pilgrim's products.

The 21-year-old fund company announced the resignations of Gary Pilgrim and Harold Baxter, its former chairman and chief executive officer, in a press release Thursday morning. Pilgrim Baxter, a division of London-based

Old Mutual

, manages the PBHG family of mutual funds.

In an earlier story,

TheStreet.com

identified the

PBHG Growth Fund

as one that might be susceptible to market-timing because it had redemption levels that far exceed its net assets, an indication of money quickly moving in and out of fund. A source said one of the funds Pilgrim's hedge fund

timed trades in was the PBHG Growth Fund.

The company said an internal review found that Pilgrim had been an investor in an unidentified hedge fund that "actively purchased and redeemed shares" of some PGHG funds and other unnamed mutual funds. The firm said Baxter, who wasn't an investor in the hedge fund, was aware of the trading activity.

The resignations at Pilgrim Baxter are the latest twist in the fast-growing mutual fund trading scandal, which has led to firings, resignations and suspensions at a nearly a dozen mutual fund companies and financial services firms, including

Alliance Capital

(AC) - Get Report

,

Bank of America

(BAC) - Get Report

,

Bank One

(ONE) - Get Report

,

Citigroup

(C) - Get Report

,

Fred Alger Management

,

Marsh & McClennan's

(MMC) - Get Report

Putnam Investments,

Merrill Lynch

(MER)

,

Prudential Securities

,

Security Trust

and

Strong Capital Management

.

A series of investigations into the $7 trillion mutual fund industry have also led to civil and criminal charges against a number of individuals, with more charges likely to be filed by authorities in the coming weeks.

Officials at Pilgrim said it began an internal investigation into potential trading irregularities in its funds in light of those investigations. The company was one of many mutual fund firms that received a subpoena during the summer from securities regulators and said it later alerted them about its finding. The company said the inappropriate trades by Gary Pilgrim's hedge fund occurred from March 2000 to December 2001.

The company said the review focused on that period because that was when the company began to take steps to eliminate market-timing in its funds.

Market-timing is an arbitrage strategy in which time differences between the closing of U.S. and foreign exchanges are exploited. While market-timing is technically legal, most mutual funds say they prohibit it because the rapid in-and-out trading by hedge funds and other investors can dilute the value of a fund's holdings and hurt other investors. That's one reason regulators are cracking down on funds that permitted some investors to engage in market timing.

Ironically, none of the prospectuses for the 12 PBHG funds expressly prohibit market-timing, even though the fund company moved to internally crack down on it. Although Pilgrim Baxter's new chief executive, David Bullock, will ask the directors of the PBHG funds to add language to its prospectuses that forbid market-timing.

Because Pilgrim officials never made any prior promise to prohibit market-timers, it's not clear if the fund company faces any regulatory liability. The company said its ousted founder intends to turn over to the company any profits he earned from the hedge fund's investment in the PBHG funds.