On a day in which Bear Stearns ( BSC) posted better-than-expected first-quarter profits , securities regulators reminded investors about the Wall Street firm's dark side.
Regulators, in reaching a $250 million settlement with Bear Stearns over its role in the mutual fund trading scandal, painted an ugly portrait of the firm as a full-service facilitator for abusive traders. "Bear Stearns was the hub that connected the many spokes of market timing and late trading, hedge funds, brokers and mutual funds,'' said Mark Schonfeld, director of the Securities and Exchange Commission's Northeast regional office. The amount of the settlement with the SEC and the New York Stock Exchange, while significant, came as no surprise to Wall Street. Back in December, Bear Stearns announced that it had reached a tentative deal with the regulatory agencies. The firm said it had set aside enough dollars to cover the penalty. What is surprising is the level of detail in the SEC's 40-page administrative complaint, documenting the wrongdoing at Bear Stearns. Using excerpts from emails and tape-recorded conversations, the complaint leaves little doubt that many people at Bear Stearns went out of their way to enable hedge funds and small brokers to engage in abusive trading. In one recorded conversation, for instance, an unidentified Bear Stearns employee is overheard cryptically explaining to a hedge fund manager how to engage in late trading by canceling a trade after hours. In fact, the complaint says employees at Bear Stearns often acted as "consultants and trouble shooters'' for rogue traders looking to score. Some hedge fund managers were so appreciative of the extra efforts of those Bear Stearns employees that they showered them with "spa gift certificates, event tickets and meals.'' More importantly, regulators say, top supervisors at Bear Stearns were aware of these activities and approved of them.
In all, Bear Stearns' mutual fund trading hub, known within the firm as the "timing desk,'' generated "hundreds of millions of dollars in profits'' for itself and its favored hedge fund customers, according to the complaint. Of the $250 million penalty Bear Stearns is paying, $160 million represents the disgorgement of profits made by the firm and its customers from 1999 to 2003. In the fall of 2003, abusive mutual fund trading largely ended when New York Attorney General Eliot Spitzer disclosed that his office had opened a sweeping investigation into the matter. Market-timing, a rapid-fire technique of mutual fund arbitrage, is a legal but frowned upon trading strategy that some mutual fund families tried to stop. But in many cases, hedge funds, with the assistance of brokers, used deceptive strategies to hide their activities. Late trading, meanwhile, is the illegal buying or selling of mutual fund shares after the 4 p.m. close, in order to take advantage of late-breaking, market-moving news. A Bear Stearns spokesman was not available for comment. Some of the allegations of the abuses carried out by the employees and senior managers of Bear Stearns' big clearing operation have been well-documented by TheStreet.com in a series of stories the past two years. TheStreet.com was the first to report on the existence of the "timing desk" and that a number of senior managing directors at Bear Stearns could face civil administrative actions by the SEC and the NYSE. Regulators, in announcing the deal with Bear Stearns, said the investigation against the individuals, many of whom still work at Bear Stearns, is continuing. In all, nine current and former Bear Stearns employees have received so-called Wells notice from the SEC in conjunction with the mutual fund investigation. As part of the settlement, Bear Stearns will have to take a number of remedial actions, including the hiring of an independent monitor to review the firm's policies and procedures in its clearing and prime brokerage operation. The firm also must establish a "compliance hot line,'' to which Bear Stearns employees can anonymously report potential wrongdoing.
Of course, this is not the first time regulators have cracked down on Bear Stearns' clearing operation, which provides back-office trading services and financing to hundreds of small brokerages and hedge funds. In 1999, the firm paid a $38.5 million fine to settle allegations that it let A.R. Baron, a rogue brokerage, carry out a stock manipulation over the firm's clearing platform. The settlement also required Bear Stearns to appoint an independent monitor. In advance of the A.R. Baron settlement, Bear Stearns hired Richard Lindsey away from the SEC to oversee its clearing business. Lindsey, former SEC director of market regulation, has not been implicated in the mutual fund scandal.