UNITED STATES OF AMERICA
In the Matter of
GARY L. PILGRIM,
ORDER INSTITUTING ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933, SECTIONS 17A(c)(4)(C) 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 AND A CEASE-AND-DESIST ORDER
The United States Securities and Exchange Commission (the "Commission") deems it appropriate and in the public interest that administrative and cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act"), Sections 17A(c)(4)(C) and 21C of the Securities Exchange Act of 1934 ("Exchange Act"), Section 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 Gary L. Pilgrim ("Pilgrim" or the "Respondent").
In anticipation of the institution of these proceedings, the Respondent has submitted an Offer of Settlement (the "Offer") that 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 in which the Commission is a party, and without admitting or denying the findings, except those findings pertaining to the jurisdiction of the Commission over him and the subject matter of these proceedings, the Respondent consents to the entry of this Order Instituting Proceedings Pursuant to Section 8A of the Securities Act, Sections 17A(c)(4)(C) and 21C of the Exchange Act of 1934, Section 203(f) and 203(k) of the Advisers Act, and Sections 9(b) and 9(f) of the Investment Company Act, Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order ("Order") as set forth below.
On the basis of this Order and Respondent's Offer, the Commission finds1 that:
1. Pilgrim is the former President, Chief Investment Officer, and Director of Pilgrim Baxter & Associates, Ltd. ("PBA"), the investment adviser to the PBHG family of mutual funds (the "PBHG Funds"); and a former director of PBHG Shareholder Services, Inc.
2. In 1995, Pilgrim, who, in addition to his other positions, managed the PBHG Growth Fund, invested in a hedge fund that was managed by a friend (the "Hedge Fund"). In March 2000, the Hedge Fund, with the knowledge and permission of Pilgrim, and contrary to the PBHG Funds' disclosed policies, began market timing, among other PBHG funds, the PBHG Growth Fund. Pilgrim did not disclose to the Board of Directors of PBA, the Board of Trustees of the funds, or to fund shareholders, that he had a substantial interest in the Hedge Fund or that the Hedge Fund had been permitted to market time in any PBHG fund.
3. Over the next 20 months, the Hedge Fund engaged in approximately 120 short-term exchange transactions in PBHG funds. From March 2000 to December 2001, the Hedge Fund's short-term trading strategy in the PBHG Funds generated a profit of approximately $9.9 million. Pilgrim's share of the Hedge Fund's realized profits during that time period was between $3.7 and $4 million. The PBHG Growth Fund reported losses of nearly 23% and 34% in 2000 and 2001, respectively.
4. Moreover, from at least June 1998 through August 2001, PBA, under the leadership of Pilgrim and PBA co-founder, Harold J. Baxter ("Baxter"), permitted several additional investors to market time certain PBHG funds, reaping profits and impacting the value of the funds to the detriment of long-term investors that the funds purported to cultivate. PBA terminated some timing activity in August 2001. However, PBA permitted the Hedge Fund, as well as additional accounts associated with the Hedge Fund's manager, and accounts associated with a personal friend of Baxter, to continue market timing PBHG funds through December 2001.
5. Pilgrim, age 64, was, at relevant times, the President, Chief Investment Officer, and Director of PBA, and the portfolio manager of the PBHG Growth Fund. He was also President of PBHG Funds and a director of PBHG Shareholder Services, Inc., a related transfer agent. Pilgrim stepped down as Chief Investment Officer in July 2001. He resigned from all other positions on or about November 11, 2003. Pilgrim and Baxter founded PBA's predecessor entity in the early 1980s. On November 20, 2003, the Commission filed an action against PBA, Pilgrim, and Baxter in federal district court in connection with the matters described herein. SEC v. Pilgrim, et al., Civil Action No. 03-CV-6341-HB (E.D. Pa.) (the "District Court Action").
6. Pilgrim Baxter & Associates, Ltd. ("PBA") is the former name of an investment adviser registered with the Commission. PBA was the investment adviser to the PBHG Funds, a Delaware statutory trust and a family of 18 mutual funds. PBHG Funds is an investment company registered with the Commission since December 1985 pursuant to Section 8 of the Investment Company Act, 15 U.S.C. § 80a-8. As of December 31, 2003, PBA managed approximately $8.7 billion in assets. PBA is an indirect wholly owned subsidiary of Old Mutual, plc, which is an international financial services company based in London, England. On November 20, 2003, the Commission filed the District Court Action against PBA. On June 21, 2004, in settlement of the District Court Action, the Commission issued against PBA an Order Instituting Administrative and Cease-And-Desist Proceedings, Making Findings and Imposing Remedial Sanctions and an Order to Cease-And-Desist Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940 and Sections 9(b) and 9(f) of the Investment Company Act of 1940 (the "PBA Order"). See In the Matter of Pilgrim Baxter & Associates, Administrative Proceeding File No. 3-11524 (June 21, 2004). On July 20, 2004, in accordance with the terms of the settlement, the District Court Action was dismissed against PBA.
7. Baxter, age 58, served as Chief Executive Officer and Chairman of the Board of Directors of PBA from its inception in 1982, until he resigned on or about November 11, 2003. Baxter was also Chairman and Trustee of the PBHG Fund, the PBHG Insurance Series Fund; a trustee of PBHG Fund Distributors, the registered broker-dealer that distributes the PBHG Funds; and a director of PBHG Shareholder Services, Inc. He resigned from these positions on or about November 11, 2003. On November 20, 2003, the Commission filed the District Court Action against Baxter.
8. Market timing includes (a) frequent buying and selling of shares of the same mutual fund or (b) buying or selling mutual fund shares in order to exploit inefficiencies in mutual fund pricing. Market timing, while not illegal per se, can harm other mutual fund shareholders because it can dilute the value of their shares if the market timer is exploiting pricing inefficiencies, or disrupt the management of the mutual fund's investment portfolio and can cause the targeted mutual fund to incur costs borne by other shareholders to accommodate frequent buying and selling of shares by the market timer.
9. Beginning in at least 1996, prospectuses of the PBHG Funds, signed by Pilgrim and other officers on behalf of the PBHG Funds and filed with the Commission, disclosed that investors would be permitted to make no more than four exchanges per year into the PBHG Cash Reserves Fund from any other PBHG fund.
10. PBA recognized the fact that timing could be detrimental to the funds and that the four-exchange limitation was in the best interest of long-term investors. At least as early as 1998, PBA internal documents reflect that PBA recognized the potential negative impact that excessive short-term trading, or market timing, could have on a portfolio manager's ability to effectively manage fund assets.
11. On March 1, 1995, Pilgrim and his wife made an initial investment of $1,057,000 in the Hedge Fund, which was managed by a friend of Pilgrim. They were two of the three original limited partners in the Hedge Fund. Over time, Pilgrim and his family members substantially increased their investment in the Hedge Fund.
12. The Hedge Fund's investing strategy consisted of actively trading shares in mutual funds based upon "a quantitative tactical asset allocation model." Its trading strategy was designed to produce profits from active trading between mutual funds holding equity securities and mutual funds holding fixed income securities. The strategy was purportedly based on a mathematical model that relied on the analysis of a combination of factors, including investment objectives and current market conditions.
13. The manager of the Hedge Fund originally agreed that the Hedge Fund would not invest in any PBHG funds. However, in 2000 the Hedge Fund's manager identified the PBHG Growth Fund as a suitable candidate for its active trading model and, in March of that year, the manager of the Hedge Fund asked Pilgrim for, at least, permission to invest in the PBHG Growth Fund. The Hedge Fund ultimately invested in several PBHG funds.
14. At that time, Pilgrim was the portfolio manager for the PBHG Growth Fund, PBHG's largest fund. As an investor in the Hedge Fund, Pilgrim was fully aware that the Hedge Fund employed a short-term trading strategy.
15. Pilgrim discussed the request with Baxter, who was aware that Pilgrim was a significant investor in the Hedge Fund and was aware that the Hedge Fund employed a short-term trading strategy. Baxter nonetheless approved the Hedge Fund's request to be allowed to trade in the PBHG Growth Fund using its active trading model.
16. Neither Pilgrim nor Baxter informed the PBHG Funds' Board of Trustees and/or shareholders that a hedge fund in which Pilgrim was a significant investor, and which employed a short-term trading strategy, had been given permission to trade in the fund that Pilgrim was managing. Nor did PBA, acting through Pilgrim and Baxter, modify the disclosures in prospectuses or otherwise inform shareholders that the Hedge Fund had been exempted from the four-exchange limitation.
17. Beginning in March 2000, this Hedge Fund actively engaged in short-term trading of the PBHG Funds. Between March and December 2000, the Hedge Fund exceeded the prospectus limitation of only four exchanges between the Cash Reserves Fund and other PBHG funds, executing 54 exchanges between either the PBHG Growth Fund or the PBHG Select Equity Fund on the one hand, and the PBHG Cash Reserves Fund on the other. The Hedge Fund's trades had an average duration of 2.24 days and an average asset value of approximately $25 million.
18. Between January 2001 and December 2001, the Hedge Fund account executed 66 exchanges between the PBHG Cash Reserves Fund and either the PBHG Growth Fund, the PBHG Technology and Communications Fund, the PBHG Select Equity Fund, or the PBHG Large Cap 20 Fund. The average trade had a duration of 2.4 days, and had an asset value of approximately $40 million.
19. Because the Hedge Fund's money always remained within the PBHG Funds rather than being withdrawn in cash, PBA earned management fees continuously on that money. From March 2000 through December 2001, PBA collected management fees of approximately $690,000 from investments by the Hedge Fund.
20. While the Hedge Fund was timing the PBHG Funds, Pilgrim continued to increase his investment in it. By the end of 2001, Pilgrim's investment had increased from $11.5 million to $28 million, which represented 45% of the Hedge Fund's assets.
21. During 2000 and 2001, the Hedge Fund realized at least $9 million in profits from its trading activity in the PBHG Funds. In contrast, the PBHG Growth Fund, in which the Hedge Fund primarily conducted its short-term trading, and which Pilgrim managed, reported losses of nearly 23% and 34% in 2000 and 2001, respectively.
22. In addition to the Hedge Fund, from 1998 through mid-2001, PBA, under the leadership of Baxter and Pilgrim, permitted more than two dozen accountholders in PBHG funds to conduct short-term trading of PBHG funds through the PBHG Cash Reserves Fund that was far in excess of the disclosed limitation of four exchanges per year. PBA monitored timing activity in the PBHG Funds and, in July 2001, took steps to limit such trading. At the peak of the timing activity, approximately 28 investors in PBHG funds, with total assets of approximately $600 million, exceeded the four-exchange policy. The PBHG Funds became known as "timer friendly." None of this timing activity was disclosed to shareholders and prospectus disclosure of the four-exchange limit remained unchanged.
23. Market timers made significant profits from June 1998 through December 2001. Similarly, PBA earned advisory fees on these timers' funds and Pilgrim and Baxter reaped multi-million dollar profits from the sale of their respective interests in PBA revenue. Meanwhile, numerous other investors in PBHG funds generally experienced a decline in the value of their investments.
24. Ultimately, in July 2001, in recognition of the deleterious effects that market timers were having on PBHG funds, PBA determined to take action against market timers, and suspended the trading of all market timers except those related to two identified entities, namely those accounts related to the manager of the hedge fund in which Pilgrim invested, and those accounts associated with the New York Broker. In August of 2001, timing assets of these two groups of timers comprised more than 60% of the PBHG Funds' known timer assets. Although PBA originally imposed certain restrictions on these timers and limited their timing capacity, these two groups of timers quickly resumed trading without limitation or restriction. PBA, under the leadership of Pilgrim and Baxter, permitted these accounts to continue timing PBHG funds until the end of 2001, when their privileges were also terminated. By the end of December 2001, while Pilgrim and Baxter were in their positions, PBA, on its own initiative, eliminated all market timing in PBHG funds.
25. At all times material to the findings in this Order, PBA acted through its principals, including Pilgrim and Baxter. As an investment adviser and officer of the PBHG Funds, Pilgrim had a fiduciary duty to act at all times in the best interest of the PBHG Funds. Accordingly, he had an affirmative obligation to act in the utmost good faith, and to provide full and fair disclosure of all material facts to the PBHG Funds. He further had an affirmative obligation to exercise reasonable care to avoid misleading the PBHG Funds.
26. As a result of the conduct described above, Pilgrim:
In determining to accept the Offer, the Commission has considered the following efforts voluntarily undertaken by the Respondent:
27. Ongoing Cooperation. Pilgrim shall cooperate fully with the Commission in any and all investigations, litigation or other formal or informal proceedings of the Commission or any federal, state, local or foreign governmental authority, or foreign securities authority, or self-regulatory organization relating to or arising from the matters described in this Order and/or set forth in the complaint in the District Court Action.
Matthew E. Fishbein, Esq.
John S. Kiernan, Esq.
Erik Bierbauer, Esq.
Debevoise & Plimpton LLP
919 Third Avenue
New York, NY 10022
Facsimile: 212/909-6836; and
28. Distribution of Disgorgement and Penalty. Pilgrim shall comply with the following undertakings:
29. Recordkeeping. Pilgrim shall preserve for a period not less than six years from the date of this Order, the first two years in an easily accessible place, any record of his compliance with the undertakings set forth in Section III.28.
30. Other Obligations and Requirements. Nothing in this Order shall relieve Pilgrim of any other applicable legal obligation or requirement, including any rule adopted by the Commission subsequent to this Order.
In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions agreed to in Pilgrim's Offer. Accordingly, it is hereby ORDERED that:
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, Pilgrim shall 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 17A(c)(4)(C) of the Exchange Act, Section 203(f) of the Advisers Act and Section 9(b) of the Investment Company Act, Pilgrim be, and hereby is barred from association with any transfer agent 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.
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.
C. Disgorgement and Civil Money Penalty
D. Respondent shall comply with the undertakings enumerated in Section III.28 and 29, above.
By the Commission.
Jonathan G. Katz
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