Edward Stern, the former hedge fund manager at the center of the mutual fund trading scandal, finally got a chance to tell his side of the story.
In a New York courtroom, Stern took the stand Friday as the prosecution's star witness in the trial of former
Bank of America
broker Theodore Sihpol, the first person to be tried on criminal charges in the more than 2-year-old scandal.
Siphol is charged with helping Stern's now-infamous Canary Capital Partner's hedge fund engage in illegal late trading of mutual fund shares. The former broker is accused of helping Canary evade the 4 p.m. cutoff time for submitting mutual fund trades, permitting Stern to profit from the impact of late-breaking, market-moving news.
The jury, which at times has seemed bored and uninterested in the testimony in the trial, paid rapt attention to Stern, whose father Leonard Stern is chairman of
Hartz Mountain Industries
and once published the
. A number of jurors took notes and none were seen nodding off, as has happened on other days.
What emerged was three hours of testimony that might have been as helpful to Sihpol as it was to New York Attorney General Eliot Spitzer.
Stern testified that he "did not feel entirely comfortable" with the late trading his hedge fund was doing with Sihpol's company. As time went on, Stern said, he had a feeling it might be wrong, even though late trading helped Canary post double-digit returns during a brutal three-year bear market.
On cross-examination Stern said he never explicitly told Sihpol that Canary was engaging in late trading. He just assumed the broker understood what was going on, given that Canary was allowed to submit trades to Bank of America up until 6:30 p.m. EDT.
In fact, Stern testified that he rarely, if ever, used the potentially incriminating phrase "late trading." Instead, he often referred to after-hours trading as "nice insurance." He said late trading was a way to insure that Canary wouldn't get burnt by late-breaking news.
"The ability to cancel an order or change an order after the 4 p.m. close was, in a way, insurance against a bad earnings announcement hitting the tape and driving down stocks the next day," Stern testified.
Stern says he occasionally used the phrase "nice insurance" in conversations with Sihpol, and assumed the broker knew what he was referring to.
Deputy Attorney General Harold Wilson had Stern read excerpts from a letter he wrote to Sihpol in May 2001 confirming their arrangement. In the letter, Stern makes reference to a February 2001 meeting with Sihpol and several other Bank of America officials, in which a 6:30 p.m. cutoff time for submitting trades was discussed.
But the letter never mentions the deadline. Stern testified he omitted the time because he wasn't "comfortable" with "putting it in writing."
On cross-examination by defense attorney Paul Schectman, Stern said he didn't think he was breaking the law.
Schectman had Stern testify that other brokers he had worked with at Brean Murray, a small New York brokerage, had a legal opinion saying late trading was permissible in some situations.
Stern also said that when he first met Sihpol in early 2001, he found the broker was not as experienced as other brokers Canary had worked with in arranging mutual fund trades.
"I didn't feel I was dealing with a typical market-timing broker," said Stern.
Market timing is the frequent trading of mutual fund shares for a quick profit. While the trading strategy is legal, it can be abusive to the interests of long-term mutual fund shareholders and many fund families try to discourage it.
In the mutual fund scandal, regulators and Spitzer's office pursued claims against mutual fund families that negotiated secret deals with hedge funds such as Canary, which permitted them to engage in market-timing.
Indeed, Stern testified he was initially interested in establishing a relationship with Bank of America so he could set up an arrangement to market time some of the bank's in-house mutual funds. Stern said that's the main reason he agreed to meet with Sihpol after receiving a "cold call" from the broker in January 2001.
It was during a subsequent meeting with Sihpol and a group of Bank of America employees that Stern learned about an electronic trading platform the bank had that would enable Canary to submit trades up until 6:30 p.m.
Stern, on cross-examination, said Sihpol said little during that meeting, and most of the discussion about the trading platform was led by a former executive with Bank of America's clearing division.
Part of Sihpol's defense strategy is to argue that his supervisors at Bank of America were aware of his dealings with Canary and that the former broker has been singled out by Spitzer's office, even though other employees were more involved in permitting Canary to make late trades. Even though Bank of America paid one of the heftiest fines in the mutual fund investigation, Sihpol is the lone person from the bank to be charged criminally.
If convicted, Sihpol faces up to 30 years in prison.
Stern, whose hedge fund has figured prominently in just about every settlement negotiated by Spitzer and the
Securities and Exchange Commission
, paid a $40 million fine to Spitzer's office. Neither Stern nor anyone associated with Canary has been charged criminally.
Stern testified that he got into the hedge fund business after managing the family's money. The Stern family fortune comes 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.