SECURITIES ACT OF 1933
Release No. 8304 / October 16, 2003
SECURITIES EXCHANGE ACT OF 1934
Release No. 48643 / October 16, 2003
INVESTMENT ADVISERS ACT OF 1940
Release No. 2183 / October 16, 2003
INVESTMENT COMPANY ACT OF 1940
Release No. 26209 / October 16, 2003
ADMINISTRATIVE PROCEEDING
File No. 3-11303
In the Matter of JAMES PATRICK CONNELLY JR., Respondent.
|
: |
ORDER INSTITUTING PUBLIC ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933, SECTIONS 15(b) AND 21C OF THE SECURITIES EXCHANGE ACT OF 1934, SECTIONS 203(f) AND 203(k) OF THE INVESTMENT ADVISERS ACT OF 1940, AND SECTIONS 9(b) AND 9(f) OF THE INVESTMENT COMPANY ACT OF 1940, MAKING FINDINGS AND IMPOSING REMEDIAL SANCTIONS |
I.
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative and cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act"), Sections 15(b) and 21C of the Securities Exchange Act of 1934 ("Exchange Act"), Sections 203(f) and 203(k) of the Investment Advisers Act of 1940 ("Advisers Act"), and Sections 9(b) and 9(f) of the Investment Company Act of 1940 ("Investment Company Act") against James Patrick Connelly Jr. ("Connelly" or "Respondent").
II.
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement (the "Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over him and the subject matter of these proceedings, which are admitted, Respondent consents to the entry of this Order Instituting Public Administrative and Cease-and-Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933, Sections 15(b) and 21C of the Securities Exchange Act of 1934, Sections 203(f) and 203(k) of the Investment Advisers Act of 1940, and Sections 9(b) and 9(f) of the Investment Company Act of 1940, Making Findings, and Imposing Remedial Sanctions ("Order"), as set forth below.
III.
On the basis of this Order and Respondent's Offer, the Commission finds1 that:
Overview
1. This is a proceeding against Connelly, a former vice chairman of Fred Alger Management Inc. ("Alger Management"). Alger Management is a registered investment adviser located in New York, NY. Alger Management manages the Alger Fund Group complex of mutual funds.
2. Connelly approved agreements permitting select investors to "time" Alger mutual funds. "Timing" refers to the practice of short term buying and selling of mutual fund shares in order to exploit inefficiencies in mutual fund pricing. Timing can adversely affect mutual fund shareholders because it can dilute the value of their shares. Consequently, mutual fund managers such as Alger Management often maintain policies and procedures to detect and prevent timing. By allowing select investors to time Alger funds, Connelly violated the antifraud provisions of the federal securities laws.
Respondent and Relevant Entity
3. Connelly, age 40, resides in Hoboken, NJ. From 1986 to 2003, Connelly was employed at Alger. Connelly holds Series 6, Series 7, Series 26 and Series 63 licenses. As vice chairman of Alger Management, Connelly was responsible for overseeing all business strategy at Alger Management, including launching new mutual funds. Connelly was named Fund Action's 2002 Fund Leader of the Year. Connelly was also a registered representative at Fred Alger & Company, Inc., a registered broker-dealer.
4. Alger Fund Group is a mutual fund complex with $6 billion of assets spread across a diversified mix of twenty-one funds. Alger Management, a subsidiary of Fred Alger & Company, Inc., was formed in 1964 and became a registered investment adviser in 1970. Alger Management serves as the manager for the mutual funds within the Alger complex.
Background - Mutual Fund Timing
5. "Timing" refers to the practice of short term buying and selling of mutual fund shares in order to exploit inefficiencies in mutual fund pricing.
6. Timing can dilute the value of mutual fund shares to the extent that a timer is permitted to buy and sell shares rapidly and repeatedly to take advantage of arbitrage opportunities. In addition, timing raises transaction costs for the fund. Consequently, mutual fund managers often maintain policies and procedures to detect and prevent timing, such as imposing early redemption fees or exercising discretion to cancel timers' purchases. Prospectuses for mutual funds often contain representations that the fund seeks to deter timers. The statement of additional information, which was incorporated by reference in the prospectus for one family of funds within the Alger complex (the "Alger Fund"), indicated that investors could make only six exchanges, or trades, of mutual funds per year. The February 28, 2003 statement of additional information indicated that "[y]ou may make up to six exchanges annually by telephone or in writing. . . . The [Alger] Fund reserves the right to terminate or modify the exchange privilege upon notice to shareholders."
Connelly Authorized Select Investors to Time Alger Funds
7. From the mid-1990s until 2003, Connelly was involved in allocating timing capacity in Alger mutual funds to timing investors. Connelly regularly authorized select investors to time the Alger Fund. Connelly did this even though he knew that the timers were making substantially more than the permitted six exchanges per year.
8. Investors seeking timing capacity usually offered to commit additional assets to other funds in the Alger complex. These additional assets were referred to as "buy and hold" positions. (Buy and hold positions are also referred to as "sticky assets.") Over time, Connelly developed a de facto practice of requiring that timers commit assets to buy and hold positions to earn access to timing capacity. In early 2003, Connelly formalized this practice by requiring that investors seeking timing capacity maintain at least 20 percent of their investment in buy and hold positions.
9. For example, in February 2003, Connelly was seeking to obtain additional assets for an Alger smallcap fund. Connelly approved an arrangement whereby Veras Investment Partners ("Veras") could time $50 million in the Alger Fund in exchange for a $10 million buy and hold position in the smallcap fund. In July 2003, Veras was granted an additional $30 million of capacity in exchange for an additional $12 million buy and hold position.
10. Connelly controlled timing activities at Alger by appointing an employee to serve as Alger's "timing police." The timing police would seek to identify investors that were timing without approval. Investors found to be timing Alger mutual funds without Connelly's approval were asked to redeem their investments in the Alger mutual funds, whereas investors who made timing agreements with buy and hold positions were permitted actively to trade Alger mutual funds. Alger Management thus treated investors differently based on whether they had a market timing agreement -- and buy and hold position commitment -- that Connelly had approved.
11. Alger's timing activity reached its peak during 2003, at which time there were more than one dozen timers with approximately $200 million of timing funds invested in Alger mutual funds. Thus, in return for providing timing capacity, Alger earned a fee on the funds invested equal to approximately 70 basis points, or 0.70 percent of the total assets invested.
12. Connelly understood that the Alger Fund prospectus and statement of additional information did not disclose that Alger Management permitted select investors to "time" Alger mutual funds and to make significantly more than six exchanges per year. Connelly also understood that the Alger mutual fund prospectus did not disclose that Alger Management required investors seeking to time Alger funds to maintain buy and hold positions in other mutual funds managed by Alger Management. Connelly further understood that Alger Management did not disclose that it treated investors differently based on whether they had entered into timing agreements in exchange for buy and hold positions. Finally, Connelly understood that allowing investors to engage in market timing of Alger funds harmed other shareholders in the "timed" funds.
Violations
13. As a result of the conduct described in paragraphs III.A through III.L above, Connelly willfully violated Section 17(a) of the Securities Act in that he, by the use of the means of instruments of transportation or communication in interstate commerce or by the use of the mails, directly or indirectly, in the offer or sale of securities, employed devices, schemes or artifices to defraud; obtained money or property by means of untrue statements of material fact or omissions to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or engaged in transactions, practices or courses of business which operated or would operate as a fraud or deceit upon purchasers or prospective purchases of such securities, as described above.
14. As a result of the conduct described in paragraphs III.A through III.L above, Connelly willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder in that he, in connection with the purchase or sale of securities, directly or indirectly, by the use of the means or instrumentalities of interstate commerce, or of the mails, employed devices, schemes or artifices to defraud; made untrue statements of material fact or omitted to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or engaged in acts, practices, or courses of business which operated or would operate as a fraud or deceit upon the purchasers of the securities, as described above.
15. As a result of the conduct described in paragraphs III.A through III.L above, Connelly willfully violated Sections 206(1) and 206(2) of the Advisers Act in that he, while acting as an investment adviser, employed devices, schemes, or artifices to defraud clients or prospective clients; and engaged in transactions, practices, or courses of business which operated or would operate as a fraud or deceit upon clients or prospective clients.
16. As a result of the conduct described in paragraphs III.A through III.L above, Connelly willfully violated Section 34(b) of the Investment Company Act in that he made untrue statements of a material fact or omitted to state facts necessary in order to prevent the statements made, in the light of the circumstances under which they were made, from being materially misleading in registration statements, applications, reports, accounts, records, or other document filed with the Commission or the keeping of which is required by registered investment companies.
IV.
In view of the foregoing, the Commission deems it is appropriate and in the public interest to impose the sanctions specified in Respondent's Offer.
Accordingly, it is hereby ORDERED:
A. Pursuant to Section 8A of the Securities Act, Section 21C of the Exchange Act, Section 203(k) of the Advisers Act, and Section 9(f) of the Investment Company Act, that Respondent cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, Sections 206(1) and 206(2) of the Advisers Act, and Section 34(b) of the Investment Company Act;
B. Pursuant to Section 15(b)(6) of the Exchange Act, Section 203(f) of the Advisers Act, and Section 9(b) of the Investment Company Act, that Respondent be, and hereby is barred from association with any broker, dealer, or investment adviser, and is prohibited from serving or acting as an employee, officer, director, member of an advisory board, investment adviser or depositor of, or principal underwriter for, a registered investment company or affiliated person of such investment adviser, depositor, or principal underwriter;
C. Any reapplication for association by the Respondent will be subject to the applicable laws and regulations governing the reentry process, and reentry may be conditioned upon a number of factors, including, but not limited to, the satisfaction of any or all of the following: (a) any disgorgement ordered against the Respondent, whether or not the Commission has fully or partially waived payment of such disgorgement; (b) any arbitration award related to the conduct that served as the basis for the Commission order; (c) any self-regulatory organization arbitration award to a customer, whether or not related to the conduct that served as the basis for the Commission order; and (d) any restitution order by a self-regulatory organization, whether or not related to the conduct that served as the basis for the Commission order; and
D. It is further ordered that Respondent shall, within 30 days of the entry of this Order, pay a civil money penalty in the amount of $400,000 to the United States Treasury. Such payment shall be: (A) made by United States postal money order, certified check, bank cashier's check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Office of Financial Management, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (D) submitted under cover letter that identifies Connelly as a Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Mark K. Schonfeld, Associate Regional Director, Northeast Regional Office, Securities and Exchange Commission, 233 Broadway, New York, NY 10279.
By the Commission.Jonathan G. Katz
Secretary
1 The findings herein are made pursuant to Respondent's Offer and are not binding on any other person or entity in this or any other proceeding.