Smelling blood in the water, Eliot Spitzer has swamped the mutual fund industry with a new round of subpoenas, with as many as a dozen firms being queried about their relationships with hedge funds.
Several sources familiar with the inquiry, which last week netted its first conviction, said the New York attorney general is focusing his investigation on late-day trading, in which favored customers are allowed to buy mutual funds that were priced prior to the release of market-moving news.
In the past few days, mutual fund giant
have confirmed receiving subpoenas from Spitzer's office, although there's no indication those fund families themselves are under investigation.
Fred Alger & Co.
, while not confirming whether it received a subpoena, said it has provided Spitzer's office with information about potential "improper late trading" involving a former customer.
Spitzer's focus on late trading means New York prosecutors are putting less emphasis on allegations of 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.
For Spitzer, the decision to focus on late-trading cases makes sense because the practice is against the law. By contrast, market-timing is largely legal. It becomes an issue only when a mutual fund that vows to prohibit market-timing violates its own rules and permits hedge funds and other investors to engage in it.
People familiar with the investigation said market-timing cases are more difficult to prove, and in the best-case scenario would result in only a civil penalty. But late trading, which Spitzer has compared to betting on a horse after the race is over, is an offense that can be criminally prosecuted.
Sources said Spitzer seems emboldened by last week's guilty plea in a late-trading case brought against Steven Markovitz, a former trader with Millennium Partners, a $3 billion New York hedge fund. Markovitz, who faces up to four years in prison, is cooperating with Spitzer's investigation.
One lawyer, who didn't want to be identified, said late-trading prosecutions make for "better headlines."
A Spitzer spokesman wouldn't comment on the emphasis of the investigation. But law-enforcement sources confirmed that late trading had become a top priority for Spitzer's office, even as it continues to look into allegations of market-timing.
Some sources speculated that Spitzer's office might be content to let the Securities and Exchange Commission, which has the power to bring only civil enforcement actions, to focus its efforts on market-timing cases. An SEC spokesman declined to comment.
But to dismiss Spitzer's emphasis on late trading as mere headline-grabbing is simplistic.
An SEC official, who didn't want to be identified, said one reason Spitzer is shifting his attention to late trading is because it's more prevalent than initially thought. People familiar with the investigation said that over the next few weeks they expect Spitzer to announce additional criminal charges against hedge fund traders and some of the brokers that assisted them in making their illegal trades.
Last month, Spitzer's office charged former
Bank of America
broker Theodore Siphol with permitting Canary Capital Management, a New Jersey hedge fund, with making late trades in shares of mutual funds sold by Nations Funds, a BofA subsidiary. There are indications that Canary, using a computer system installed by BofA to facilitate those illegal trades, made after-hours trades in shares of other mutual funds.
Siphol has pleaded not guilty to the charges pending against him in New York state Supreme Court.
In the Canary case, which Spitzer settled by imposing a $40 million fine on the hedge fund and its managing partner, Edward Stern, allegations of market-timing were leveled against mutual funds sold by
So far, Spitzer's office hasn't charged any mutual fund family with either permitting late trading or engaging in market-timing.