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U.S. Securities and Exchange Commission

UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION

Securities Act of 1933
Release No. 8506 / November 17, 2004

Securities Exchange Act of 1934
Release No. 50681 / November 17, 2004

Investment Advisers Act of 1940
Release No. 2329 / November 17, 2004

Investment Company Act of 1940
Release No. 26656 / November 17, 2004

Admin. Proc. File No. 3-11740





In the Matter of

HAROLD J. BAXTER,

Respondent.






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ORDER INSTITUTING ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933, SECTIONS 15(b)(6), 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

I.

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 15(b)(6), 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 Harold J. Baxter ("Baxter" or the "Respondent").

II.

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 15(b)(6), 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.

III.

On the basis of this Order and Respondent's Offer, the Commission finds1 that:

Overview

1. Baxter is the former Chief Executive Officer and Chairman of the Board of Directors of Pilgrim Baxter & Associates, Ltd. ("PBA"), the investment adviser to the PBHG family of mutual funds (the "PBHG Funds"). He also is the former Chairman and Trustee of the PBHG Funds and the PBHG Insurance Series Fund, a trustee of PBHG Fund Distributors, and a director of PBHG Shareholder Services, Inc.

2. From at least June 1998 through August 2001, PBA, under the leadership of Baxter and PBA co-founder, Gary L. Pilgrim ("Pilgrim"), permitted several investors, including investors associated with personal friends of Baxter and Pilgrim, to market time certain PBHG funds through the PBHG Cash Reserves Fund, despite statements in the prospectuses of the PBHG Funds prohibiting such activity. Investors that PBA permitted to market time PBHG funds reaped profits from this privilege, and their timing activity impacted the value of the funds to the detriment of long-term investors. In August 2001, PBA terminated the activity of many timers. Notwithstanding, it permitted customers of a New York brokerage firm run by a friend of Baxter (the "New York Broker"), as well as additional accounts affiliated with a friend of Pilgrim, to continue market timing certain PBHG funds through December 2001. By the end of December 2001, while Baxter and Pilgrim were in their positions, PBA, on its own initiative, eliminated all market timing in PBHG funds.

3. In addition to permitting extensive market timing at PBA, Baxter instructed that certain non-public, 30-day stale portfolio holdings information pertaining to certain PBHG funds be provided to his friend, the President of the New York Broker. The President of the New York Broker, in turn, provided the nonpublic information to customers of the New York Broker to use to facilitate market timing of certain PBHG funds and to exercise hedging strategies through other financial and brokerage institutions. Baxter did not disclose to the Board of Directors of PBA, the Board of Trustees of the PBHG Funds, or to fund shareholders, that he was providing the non-public information to his friend or that clients of the New York Broker, among others, had been permitted to extensively market time in PBHG funds to the detriment of other shareholders in those funds.

Respondent

4. Harold J. 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 and Pilgrim founded PBA's predecessor entity in the early 1980s. Baxter was also Chairman and Trustee of the PBHG Funds and the PBHG Insurance Series Fund; a trustee of PBHG Fund Distributors, the registered broker-dealer that distributes PBHG funds; and a director of PBHG Shareholder Services, Inc., a related transfer agent. He resigned from these positions on or about November 11, 2003. 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").2

Other Relevant Entities

5. Pilgrim Baxter & Associates, Ltd. is the former name of an investment adviser registered with the Commission.3 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.

6. Gary L. 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. Pilgrim stepped down from the position of Chief Investment Officer in July 2001, and resigned from the remaining positions on or about November 11, 2003. On November 20, 2003, the Commission filed the District Court Action against Pilgrim.

Facts

7. 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.

The PBHG Funds' Disclosures Regarding Short-Term Trading

8. Beginning in at least 1996, prospectuses of the PBHG Funds, signed by Baxter 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.

9. PBA and its officers 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.

Short-Term Trading In The PBHG Funds

10. 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.

11. 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, among other things, the sale of their respective interests in PBA revenue.4 Meanwhile, numerous other investors in PBHG funds generally experienced a decline in the value of their investments.

12. Pilgrim was a significant investor in one of these accountholders, a hedge fund. Baxter was aware of Pilgrim's investment but, nonetheless, approved this accountholder's request to market time, at least, the PBHG Growth Fund, which was managed by Pilgrim. Neither Pilgrim nor Baxter informed the PBHG Funds' Board of Trustees and/or shareholders that an accountholder in which Pilgrim was a significant investor had been given permission to market-time the very fund that Pilgrim was managing.

13. Ultimately, in July 2001, in recognition of the deleterious effects that market timers were having on PBHG funds, PBA, under the leadership of Pilgrim and Baxter, determined to take action against market timers, and suspended the trading of all market timers except those related to two 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 Baxter and Pilgrim were in their positions, PBA, on its own initiative, eliminated all market timing in PBHG funds.

The Provision of Non-Public Information to the New York Broker

14. In 1998, at Baxter's direction, PBA began providing 30-day stale, material, and non-public portfolio holdings of certain PBHG funds to Baxter's friend, the President of the New York Broker. PBA continued to provide this information to the President of the New York Broker through September 2003.

15. The President of the New York Broker provided this information to his firm's customers, who used the information to market time the PBHG Funds and to exercise hedging strategies through other financial and brokerage institutions.

16. At all times material to the findings in this Order, PBA acted through its principals, including Pilgrim and Baxter. As a high level executive of an investment adviser and chairman/trustee to the PBHG Funds, Baxter 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.

Violations

17. As a result of the conduct described above, Baxter:

  1. willfully violated Section 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder;
     
  2. willfully aided and abetted and caused PBA's violations of Sections 204A, 206(1) and 206(2) of the Advisers Act; and
     
  3. willfully violated Section 34(b) of the Investment Company Act.
     

Certain Voluntary Undertakings

In determining to accept the Offer, the Commission has considered the following efforts voluntarily undertaken by the Respondent:

18. Ongoing Cooperation. Baxter 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.

  1. In connection with such cooperation, Baxter has undertaken and will undertake to:
     
    1. Produce, without service of a notice or subpoena, any and all documents and other information reasonably requested by the Commission's staff;
       
    2. Use his best efforts to be interviewed by the Commission's staff at such times as the staff reasonably may direct and to appear and testify truthfully and completely without service of a notice or subpoena in such investigations, depositions, hearings or trials as may be requested by the Commission's staff; and
       
  2. In connection with any testimony of Baxter to be conducted at deposition, hearing, or trial pursuant to a notice or subpoena, Baxter:
     
    1. Agrees that any such notice or subpoena for his appearance and testimony may be served by regular mail on his attorneys, as set forth below:
       
    2. Thomas J. Allingham II, Esq.
      Jennifer C. Voss, Esq.
      Skadden, Arps, Slate, Meagher & Flom LLP
      One Rodney Square
      P.O. Box 636
      Wilmington, Delaware 19899-0636
      Facsimile: 302/651-3001; and

    3. Agrees that any such notice or subpoena for Baxter's appearance and testimony in an action pending in a United States District Court may be served, and may require testimony, beyond the territorial limits imposed by the Federal Rules of Civil Procedure.
       
  3. In connection with such cooperation, upon a request by the Commission's staff sent in writing to the names and address set forth above in Section III.18.b.1., Baxter further agrees to waive any evidentiary privileges or protections from discovery in connection with any and all investigations, litigation or other proceedings relating to or arising from the matters described in this Order and/or set forth in the complaint in the District Court Action, subject to the following limitations:
     
    1. Baxter will not waive any evidentiary privileges or protections from discovery with respect to any and all communications that occurred between Baxter and Skadden, Arps, Slate, Meagher & Flom LLP ("Skadden") if such communications were not shared with, and were made out of the presence of and without the participation of, any third party;
       
    2. Baxter will not waive any evidentiary privileges or protections from discovery with respect to any attorney work product created by Skadden if such work product was not shown to, created with, and/or shared with any third party;
       
    3. Notwithstanding the provisions of Section III.18.c.1 and 2, Baxter will not waive any evidentiary privileges or protections from discovery with respect to any and all communications that have occurred, and/or any attorney work product created, on or after November 20, 2003; and
       
    4. For purposes of Sections III.18.c.1 and 2, "third party" includes any agents or representatives of PBA or its related entities other than Baxter and Pilgrim.
       
  4. The Commission will not deem Respondent's good faith invocation of his rights against self-incrimination to be in violation of this Section III.18.
     

Undertakings

19. Distribution of Disgorgement and Penalty. Baxter shall comply with the following undertakings:

  1. Baxter shall cooperate fully with the Independent Distribution Consultant retained by PBA in connection with In the Matter of Pilgrim Baxter & Associates, Administrative Proceeding File No. 3-11524 (June 21, 2004) (the "PBA Order").
     
  2. Baxter shall pay his pro-rata share of all costs and/or expenses associated with the administration of the Distribution Plan described in Section IV.C.2, below. For the purposes of this paragraph, Baxter's pro-rata share shall be the percentage of the money to be distributed that is attributable to the money paid by Baxter pursuant to paragraph IV.C.1. below, including all interest and earnings thereon, at the time of administration of the Distribution Plan.
     

20. Recordkeeping. Baxter 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.19.

21. Other Obligations and Requirements. Nothing in this Order shall relieve Baxter of any other applicable legal obligation or requirement, including any rule adopted by the Commission subsequent to this Order.

IV.

In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions agreed to in Baxter'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, Baxter 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; and shall cease and desist from causing any violations and any future violations of Section 204A of the Advisers Act.

B. Pursuant to Sections 15(b)(6) and 17A(c)(4)(C) of the Exchange Act, Section 203(f) of the Advisers Act, and Section 9(b) of the Investment Company Act, Baxter be, and hereby is barred from association with any broker, dealer, 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

  1. Respondent shall pay, no later than January 31, 2005, disgorgement in the total amount of $60 million ("Disgorgement") and a civil money penalty in the amount of $20 million ("Penalty"), for a total payment of $80 million.
     
  2. The Disgorgement and Penalty, and any interest or earnings thereon, shall be distributed in accordance with the Distribution Plan developed in connection with the PBA Order and approved by Commission order as provided in Rule 1104 of the Commission's Rules of Practice [17 C.F.R. 201.1104].
     
  3. There shall be, pursuant to Section 308(a) of the Sarbanes Oxley Act of 2002, a Fair Fund established for the funds described in Section IV.C.1. Regardless of whether any such Fair Fund distribution is made, amounts ordered to be paid as civil money penalties pursuant to this Order shall be treated as penalties paid to the government for all purposes, including all tax purposes. To preserve the deterrent effect of the civil penalty, Respondent agrees that he shall not, after offset or reduction of any award of compensatory damages in any Related Investor Action based on Respondent's payment of disgorgement in this action, further benefit by offset or reduction of such compensatory damages award by the amount of any part of Respondent's payment of a civil penalty in this action ("Penalty Offset"). If the court in any Related Investor Action grants such a Penalty Offset, Respondent agrees that he shall, within 30 days after entry of a final order granting the Penalty Offset, notify the Commission's counsel in this action and pay the amount of the Penalty Offset to the United States Treasury or to a Fair Fund, as the Commission directs. Such a payment shall not be deemed an additional civil penalty and shall not be deemed to change the amount of the civil penalty imposed in this proceeding. For purposes of this paragraph, a "Related Investor Action" means a private damages action brought against Respondent by or on behalf of one or more investors based on substantially the same facts as alleged in the Order instituted by the Commission in this proceeding.
     
  4. Pursuant to an escrow agreement not unacceptable to the staff of the Commission, Respondent shall make the payment described in paragraphs IV.C.1 into an escrow account. The escrow agreement shall, among other things: (1) require that all funds in escrow be invested as soon as reasonably possible and to the extent practicable in short-term U.S. Treasury securities with maturities not to exceed six months; (2) name an escrow agent who shall be appropriately bonded; and (3) provide that escrowed funds be disbursed only pursuant to an order of the Commission. Respondent shall be responsible for all costs and/or expenses associated with the escrow agreement. Any and all taxes payable on account of income earned by the money in the escrow account shall be timely paid from funds in the escrow account, and the escrow agent is authorized and directed to make such payments.
     

D. Respondent shall comply with the undertakings enumerated in Section III.19-20, above.

By the Commission.

Jonathan G. Katz
Secretary


Endnotes


http://www.sec.gov/litigation/admin/33-8506.htm


Modified: 11/17/2004