Veras Investment Partners
, a Texas hedge fund that securities regulators contend engaged in improper trading of mutual fund shares, has set aside more than $100 million to cover the cost of a possible settlement with state and federal regulators, according to several sources.
The Sugar Land, Texas-based fund, which ceased operations a few weeks ago, notified its investors about the reserve account during a recent conference call, said sources familiar with the hedge fund and the mutual fund industry trading investigation.
Veras, which is being investigated by New York Attorney General Eliot Spitzer and the
Securities and Exchange Commission
, has not been charged with any wrongdoing. But the 2-year-old hedge fund, which may have had $1 billion in assets at its height, has been linked to possible improper and illegal trading in shares of several mutual fund companies.
Sources said the amount of money set aside for settlement purposes far exceeds the $40 million the
Canary Capital Partners
hedge fund paid as a fine to settle with Spitzer's office. The Canary settlement and the revelations about illegal trading in mutual funds share sparked a firestorm on Wall Street and has led to a far-reaching investigation into the $7.1 trillion mutual fund industry.
Veras may have set aside up to $200 million in a settlement reserve, said sources familiar with the hedge fund and the fund industry investigation. An investor in the hedge fund said a Veras executive told him that the SEC advised the hedge fund to place as much as $100 million in an escrow account for a possible settlement with regulators.
Officials at Veras, which was started by James McBride and Kevin Larsen, declined to comment. Rich Zabel, a partner with Akin Gump Strauss Hauer & Feld, Veras' law firm, also declined to comment. Officials at the SEC and Spitzer's office also did not comment.
The establishment of a reserve account does not mean a settlement between Veras and regulators is imminent, sources said, but is an indication that regulators consider the allegations against Veras to be serious.
"It would come as a surprise to me that a party would need to establish a reserve in order to pay a fee or penalty to a regulator, unless the party conspired with officers or employees of those mutual funds," said Ron Geffner, an attorney with Sadis & Goldberg in New York who specializes in advising hedge funds.
The SEC's warning to Veras about setting up a reserve account also may signal that some of the other hedge funds implicated in the mutual trading scandal --
Chronos Asset Management
Samaritan Asset Management
, to name a few -- may be forced to pay stiff fines and penalties. Officials at those three hedge funds could not be reached for comment.
Veras established the settlement reserve at the same time it began winding down its operations. One Veras investor said the fund has returned between $400 million and $500 million to its investors, with most small investors receiving about 85% of their money.
Regulators have been focusing on Veras for quite some time. The hedge fund confirmed in October that it had received subpoenas from Spitzer's office and the SEC.
Veras, a statistical arbitrage hedge fund, allegedly made improper trades in shares of mutual funds sold by
Fred Alger Management
, according to regulators and a Federated corporate filing. Veras' name also surfaced in a civil fraud complaint filed by Massachusetts securities regulators against
Marsh & McLennan's
Putnam Investments, the big Boston-based mutual fund company that allegedly permitted some of its portfolio managers to engage in improper trading.
Regulators allege Veras may have engaged in both market-timing and late trading of shares of mutual funds, the two kinds of improper trading into which the government investigations have focused. Federated, for instance, said it found that Veras made 15 late trades in some of it mutual funds.
On Dec. 17, James Connelly, a former Fred Alger executive, was sentenced to serve one to three years in a New York state prison on an obstruction of justice charge. Spitzer's office charged that Connelly tried to delete company emails that detailed some of Veras' trading activities.
Regulators consider late trading a more serious offense because it permits favored customers to buy -- or cancel an order to buy -- shares of mutual funds after the close of the trading day. The late trades enable customers to take advantage of late-breaking news because orders are processed at an old price, rather than the next day's closing price reflecting individual stocks' movement.
Market-timing is the term for a legal but strongly discouraged trading strategy in which mutual fund shares are bought and sold frequently to capitalize on price discrepancies in different markets. The rapid-fire trading is harmful for the vast majority of mutual fund investors because it can dilute the value of a fund by driving up trading and administrative costs.
Most fund companies disclose in their prospectuses that they try to ferret out and stop market-timers. But investigators have found that far too many fund companies were willing to bend or ignore those rules when it came to a privileged group of hedge funds and their brokers.
Veras is one of several hedge funds and brokerage firms that had obtained an advisory opinion from its lawyers, which concluded that some late trading may be legal, despite regulators' contentions. Attorneys at Akin Gump wrote the Veras advisory opinion.
The legal opinions, some of which were not put into writing, are said to focus on what some see as a potential loophole in the securities regulation that's supposed to prohibit late trading -- the "price forward rule." These opinions point out that the regulation never states that all orders to buy or sell mutual fund shares must be submitted to the fund company by the 4 p.m. close of the trading day.
This omission in the price forward rule may leave the door open for some late trading through a broker intermediary, as long as it takes place before a mutual fund company calculates that day's net asset value, or NAV, for the shares of a particular fund. Many mutual funds don't actually calculate the NAVs for their funds until 5:30 p.m., or 90 minutes after the 4 p.m. close.
The SEC recently proposed new rules that would eliminate the late trading loophole, as well as make it difficult for investors to engage in market-timing.
But it's unclear how much the legal advisory opinions may help hedge funds such as Veras.
Sources familiar with the investigation said Canary, the hedge fund run by Edward Stern that triggered the mutual fund investigation, also had an advisory opinion from its lawyers, which gave the green light to some late trading.