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IN THE UNITED STATES DISTRICT COURT
COMPLAINT Plaintiff Securities and Exchange Commission (the "Commission") alleges for its Complaint the following: SUMMARY 1. This matter involves fraud by Gary L. Pilgrim ("Pilgrim") and Harold J. Baxter ("Baxter"), former President and CEO, respectively, of Pilgrim Baxter & Associates, Ltd. ("Pilgrim Baxter"), the investment adviser to the PBHG family of mutual funds. Pilgrim and Baxter founded the PBHG fund family in the early 1980's. Pilgrim, who, in addition to his other positions, was the portfolio manager for the PBHG Growth Fund, invested in a hedge fund, Appalachian Trails, L.P. ("Appalachian"), in 1995. Both Pilgrim and Harold Baxter knew that Appalachian's trading strategy involved short-term trading ("market timing") of mutual funds. In March 2000, Appalachian, with the knowledge and approval of both Pilgrim and Baxter, and contrary to the PBHG funds' disclosed policies, began market timing several PBHG funds, primarily the PBHG Growth Fund managed by Pilgrim. Neither Pilgrim nor Baxter ever disclosed to the Board of Pilgrim Baxter, the Board of Trustees of the funds, or to fund shareholders, that Pilgrim had an extensive interest in Appalachian or that Appalachian had been permitted to market time in PBHG funds. 2. Over the next 20 months, Appalachian engaged in approximately 120 short-term exchange transactions in PBHG funds. From March 2000 to December 2001, Appalachian's short-term trading strategy in the PBHG funds generated a profit of approximately $13 million. Pilgrim's share of Appalachian's profits during that time period was approximately $3.9 million. 3. Meanwhile, Baxter improperly provided non-public portfolio information to another PBHG client, which was used by other market timers to both market time the PBHG funds and to advance their investment strategies through other financial and brokerage institutions. 4. By engaging in the activities alleged in this Complaint, defendants Pilgrim, Baxter, and Pilgrim Baxter, engaged in acts, transactions, practices and courses of business that constitute violations of Section 17(a) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77q(a); Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5; and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940 ("Advisers Act"), 15 U.S.C. §§ 80b-6(1) and 80b-6(2). Alternatively, Baxter aided and abetted Pilgrim Baxter's violations of Sections 206(1) and 206(2) of the Advisers Act, 15 U.S.C. §§ 80b-6(1) and 80b-6(2). 5. By engaging in the conduct described herein, defendant Pilgrim Baxter also violated, and defendant Baxter aided and abetted Pilgrim Baxter's violation of, Section 204A of the Advisers Act, 15 U.S.C. § 80b-4a. 6. Unless restrained and enjoined, Defendants Pilgrim, Baxter, and Pilgrim Baxter will continue to engage in acts, transactions, practices, and courses of business as set forth in this Complaint or in acts, transactions, practices, and courses of business of similar object and purpose. Accordingly, the Commission seeks: (i) the entry of a permanent injunction prohibiting them from further violations of the relevant provisions of the federal securities laws; (ii) the entry of a permanent injunction against Pilgrim and Baxter pursuant to Section 36(a) of the Investment Company Act, 15 U.S.C. § 80a-35(a); (iii) disgorgement of all unjust enrichment, plus prejudgment interest thereon; (iv) the imposition of civil monetary penalties due to the egregious nature of their violations; and (v) other equitable relief. JURISDICTION AND VENUE 7. The Commission brings this action pursuant to authority conferred by Section 20(b) of the Securities Act, 15 U.S.C. § 77t(b); Sections 21(d) and (e) of the Exchange Act, 15 U.S.C. §§ 78u(d) and (e); and Section 209 of the Advisers Act, 15 U.S.C. § 80b-9, to enjoin such acts, transactions, practices and courses of business, obtain disgorgement and prejudgment interest, civil penalties, and for other appropriate relief; and pursuant to Section 36(a) of the Investment Company Act, 15 U.S.C. § 80a-35(a), to enjoin defendants Pilgrim and Baxter from acting as an officer, director, member of any advisory board, investment adviser, or depositor of any registered investment company, or as a principal underwriter for any registered investment company which is an open-end company, unit investment trust, or face-amount certificate company, either permanently or temporarily. 8. This Court has jurisdiction over this action pursuant to Section 22(a) of the Securities Act, 15 U.S.C. § 77v(a); Section 27 of the Exchange Act, 15 U.S.C. § 78aa; Section 214 of the Advisers Act, 15 U.S.C. § 80b-14; and Section 44 of the Investment Company Act, 15 U.S.C. § 80a-43. 9. The defendants reside, can be found and/or transact business in this district, and certain of the acts, transactions, practices and courses of business constituting the violations alleged herein occurred within the Eastern District of Pennsylvania and elsewhere, and were effected, directly or indirectly, by making use of the means and instruments of transportation and communication in interstate commerce, or the means and instrumentalities of interstate commerce, the mails, or the facilities of a national securities exchange. DEFENDANTS 10. Gary L. Pilgrim, age 63, was, at all relevant times, the President, Chief Investment Officer, and Director of Pilgrim Baxter, and the portfolio manager of the PBHG Growth Fund. He was also President of the PBHG Fund. Pilgrim resigned from these positions on November 13, 2003. Pilgrim resides in Malvern, Pennsylvania. 11. Harold J. Baxter, age 57, served as chief executive officer and chairman of Pilgrim Baxter from its inception in 1982, until he resigned on November 13, 2003. Baxter was also chairman and trustee of the PBHG Fund and the PBHG Insurance Series Fund, positions from which he resigned on November 13, 2003. Baxter resides in Berwyn, Pennsylvania. 12. Pilgrim Baxter & Associates, Ltd. is an indirect wholly owned subsidiary of Old Mutual plc, which is an international financial services group based in London. Pilgrim Baxter is an investment adviser registered with the Commission, and is the investment adviser to the PBHG Fund, a Delaware business trust and a family of 18 mutual funds. PBHG Fund 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. RELATED PARTIES 13. AT, L.P., a/k/a Appalachian Trails, L.P., is a Delaware limited partnership. AT, L.P. is a private investment partnership, which maintained hedge fund accounts under the name of "Appalachian Trails" at Pilgrim Baxter. 14. Michael G. Christiani, age 43, is the founder, chairman and CEO of CPTR, LLC, which acts as the general partner of AT, L.P., and which manages the Appalachian hedge fund accounts. FACTS Excessive Short-Term Trading 15. Excessive short-term trading in mutual funds can be detrimental to long-term shareholders in those funds. Such trading can dilute the value of mutual fund shares to the extent that a trader may buy and sell shares rapidly and repeatedly take advantage of inefficiencies in the way mutual fund prices are determined. Dilution could occur if fund shares are overpriced and redeeming shareholders receive proceeds based on the overvalued shares. In addition, short-term trading can raise transaction costs for the fund, it can disrupt the fund's stated portfolio management strategy, require a fund to maintain an elevated cash position, and result in lost opportunity costs and forced liquidations. Short-term trading can also result in unwanted taxable capital gains for fund shareholders and reduce the fund's long-term performance. In short, while individual shareholders may profit from engaging in short-term trading of mutual fund shares, the costs associated with such trading are borne by all fund shareholders. Consequently, investment advisers often maintain policies and procedures to detect and prevent market timing and other short-term trading. 16. As an investment adviser, each of the defendants had a fiduciary duty to act at all times in the best interest of their clients. Accordingly, each of the defendants had an affirmative obligation to act in the utmost good faith, and to provide full and fair disclosure of all material facts to their clients. They further had an affirmative obligation to apply reasonable care to avoid misleading their clients. At all times material hereto, defendant Pilgrim Baxter acted through defendants Pilgrim and Baxter. PBHG Fund Prospectus Disclosures Regarding Short-Term Trading 17. From 1996 to the present, the PBHG Fund prospectus, signed by Baxter and Pilgrim on behalf of the PBHG funds contained the following disclosure regarding short-term trading:
This provision pertained to each individual mutual fund that comprised the PBHG funds from 1996 to the present, and contained no provision that provided an exception to this policy for any particular customer. 18. Internal documents reflect that the PBHG funds recognized the negative impact associated with excessive short-term trading, or market timing, on a portfolio manager's ability to effectively manage the assets of their funds at least as early as 1998. The fund family also recognized the fact that the four exchange limitation was in the best interests of long-term shareholders. 19. Nevertheless, numerous PBHG Fund accountholders conducted short-term trading of the PBHG funds through the PBHG Cash Reserve Fund that was far in excess of PBHG's disclosed limitation of four exchanges per year. Pilgrim Baxter monitored timing activity in the PBHG funds and, in July 2001, took some steps to limit such trading. At its peak, approximately 28 PBHG Fund accountholders were in violation of the four exchange policy, and their accounts contained total assets of approximately $600 million. Pilgrim's Initial Investment in Appalachian and Appalachian's
20. In 1995, Christiani formed AT, L.P. and solicited Pilgrim to make a personal investment in the Appalachian hedge fund. 21. According to offering materials sent to Pilgrim on February 2, 1995, Appalachian's trading strategy consisted of actively trading shares in mutual funds based upon "a quantitative tactical asset allocation model." The private offering memorandum described the trading strategy as follows:
22. Appalachian's 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. 23. In a letter to Pilgrim dated February 2, 1995, Christiani explicitly stated that Appalachian would not invest in any of the PBHG funds. On March 1, 1995, Pilgrim and his wife made an initial investment of $1,057,000 in Appalachian. They were two of the three original limited partners in Appalachian. Over time, Pilgrim and his family members substantially increased their investment in Appalachian. Baxter and Pilgrim Approve Appalachian's Request to Trade in the PBHG Fund 24. In fact, Appalachian did not trade in the PBGH Funds until 2000. At that time, Christiani identified the PBHG Growth Fund as a suitable candidate for engaging in such short-term trading activity and, in March 2000, Christiani asked Pilgrim for permission to invest through Appalachian in that fund, and other PBHG funds. 25. At that time, Pilgrim was the portfolio manager for the PBHG Growth Fund, PBHG's largest fund. As discussed above, Pilgrim was also an investor in Appalachian and fully aware of Appalachian's short-term trading strategy. 26. Pilgrim discussed the request with Baxter who, with knowledge that Pilgrim was personally and significantly invested in Appalachian and knowledge of Appalachian's short-term trading strategy, approved Appalachian's request to trade in the PBHG Growth Fund. 27. Neither Pilgrim nor Baxter informed any other Pilgrim Baxter or PBGH Funds board member of either Pilgrim's financial interest in Appalachian or their approval of Appalachian's request to, in effect, market time the PBGH Growth Fund. They further did not modify the prospectus or otherwise inform shareholders of this exception to the four exchange limitation. Appalachian Begins Conducting Extensive Short-Term Trading in the PBHG Fund 28. Beginning in March 2000, Appalachian actively engaged in short-term trading of the PBHG Fund. Consistent with the strategy set forth in its offering materials, Appalachian traded primarily between the PBHG Growth Fund, which held equity securities, and the PBHG Cash Reserves Fund, a money market fund which held a fixed income portfolio. 29. Between March and December 2000, Appalachian blatantly exceeded the PBHG limitation of only four exchanges between the Cash Reserves Fund and other PBHG funds. During that time period, the Appalachian account executed 54 exchanges between either the PBHG Growth Fund or the PBHG Select Growth Fund; and the PBHG Cash Reserves Fund. The average short-term trade, or "round trip," had a duration of 2.24 days, and had an asset value of more than $25 million. The defendants knew or were reckless in not knowing of this trading activity. 30. Between January 2001 and December 2001, the Appalachian account executed 66 exchanges between the PBHG Growth Fund, the PBHG Technology and Communications Fund, the PBHG Select Equity Fund, or the PBHG Large Cap 20 Fund; and the PBHG Cash Reserves Fund. The average short-term trade had a duration of 2.4 days, and had an asset value of more than $40 million. The defendants knew or were reckless in not knowing of this trading activity. 31. Appalachian's funds always remained within the PBHG fund family, thereby allowing Pilgrim Baxter to continue to earn management fees on those assets. From March 2000 through December 2001, Pilgrim Baxter collected management fees of approximately $690,000 from the handling of Appalachian's account. 32. In late 2000, after permitting Appalachian to market time the PBHG funds, Pilgrim increased his investment in Appalachian from $11.5 million to $18 million, which represented 35 percent of Appalachian's assets. By the end of 2001, Pilgrim's investment had increased to $28 million, which represented 45 percent of Appalachian's assets. This amount included at least $8 million in additional funds invested by Pilgrim during those two years. 33. During 2000 and 2001, Appalachian realized approximately $13 million in profits from its trading activity in the PBHG funds. Pilgrim's share of Appalachian's profits during that time was approximately $3.9 million. 34. In contrast, the PBHG Growth Fund, in which Appalachian primarily conducted its short-term trading, reported losses of nearly 23 percent and 34 percent in 2000 and 2001, respectively. PBHG Prohibits all Excessive Short-Term Trading of its Funds By All But Two Clients 35. In July 2001, Pilgrim Baxter and PBHG Fund officials met to discuss the disruptive effects of market timers in the PBHG Fund. They determined that, in light of the volatility of the stock market, the market timing activity had become a serious problem and needed to be prohibited. As of July 2001, Pilgrim Baxter identified approximately 28 known market timers. In August 2001, Pilgrim Baxter began informing known and suspected market timers that they would no longer be able to engage in exchanges or other short-term trading activities in the PBHG Fund. 36. Baxter and Pilgrim, however, specifically exempted the funds of two clients from the market timing prohibition: Christiani (and, consequently, Appalachian), and The Wall Street Discount Corporation ("Wall Street Discount"), a broker-dealer. These clients were allowed to continue their market timing activities. These two accounts represented more than 50 percent of the assets being timed through the funds by the approximately 28 known timers. In July 2001, Pilgrim Baxter purportedly told Appalachian that it would have to reduce its allowable market timing capacity from $63 million to $50 million and, similarly, told Wall Street Discount that it would have to reduce its allowable market timing capacity from $537 million to $250 million. 37. Several Wall Street Discount customers market timed the PBHG Fund through Wall Street Discount. Baxter Provides Non-Public, Material Information to Outsiders 38. From as early as 1998 and as recently as September 2003, Baxter deliberately and repeatedly provided PBGH Fund portfolio holdings, which were thirty days stale, to his long-time personal friend, Alan Lederfeind, president and chief executive officer of Wall Street Discount. When provided, these portfolio holdings were material, nonpublic information. Lederfeind, in turn, passed this information to Wall Street Discount customers. These customers used the PBHG portfolio information to market time the PBHG funds and to exercise hedging strategies through other financial and brokerage institutions. 39. By December 2001, Pilgrim Baxter determined that even the remaining short-term trading by Appalachian and Wall Street Discount was overly disruptive and stopped allowing market timing completely. FIRST CLAIM Direct Violations of Sections 206(1) and 206(2) of the Advisers Act 40. Paragraphs 1 through 39 are realleged and incorporated herein by reference. 41. During the period set forth above, defendants Pilgrim, Baxter and Pilgrim Baxter made use of the means and instrumentalities of interstate commerce and of the mails while acting as an investment adviser. 42. As a result of the conduct alleged herein, defendants, directly and indirectly, by use of the mails and the means and instrumentalities of interstate commerce: (a) employed devices, schemes and artifices to defraud investment advisory clients and prospective clients; and (b) engaged in transactions, practices and courses of business which operated as a fraud and deceit upon such clients and prospective clients. By reason of the foregoing, defendants Pilgrim, Baxter and Pilgrim Baxter violated Sections 206(1) and 206(2) of the Advisers Act, 15 U.S.C. §§ 80b-6(1) and 80b-6(2). SECOND CLAIM Aiding and Abetting Violations of Sections 206(1) and 206(2) of the Advisers Act 43. Paragraphs 1 through 42 are realleged and incorporated herein by reference. 44. During the period set forth above, defendant Baxter made use of the means and instrumentalities of interstate commerce and of the mails while acting as an investment adviser. 45. As a result of the conduct alleged herein, defendants Pilgrim and Pilgrim Baxter, directly and indirectly, by use of the mails and the means and instrumentalities of interstate commerce: (a) employed devices, schemes and artifices to defraud investment advisory clients and prospective clients; and (b) engaged in transactions, practices and courses of business which operated as a fraud and deceit upon such clients and prospective clients; and defendant Baxter aided and abetted Pilgrim Baxter's and Pilgrim's violations of Sections 206(1) and 206(2) of the Advisers Act, 15 U.S.C. §§ 80b-6(1) and 80b-6(2). THIRD CLAIM Violations of Section 17(a) of the Securities Act, Section 10(b) 46. Paragraphs 1 through 45 are realleged and incorporated herein by reference. 47. As set forth herein, defendants Pilgrim Baxter, Pilgrim and Baxter, in connection with the offer, purchase or sale or securities, directly or indirectly, by use of the means or instruments of transportation or communication in interstate commerce, or the means or instrumentalities of interstate commerce, or the mails, or the facilities of a national securities exchange: (a) employed devices, schemes or artifices to defraud; (b) obtained money or property by means of, or made, untrue statements of material fact, or omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; and (c) engaged in acts, transactions, practices, or courses of business which operated as a fraud or deceit upon offerees, purchasers and prospective purchasers of securities. 48. By reason of the foregoing, defendants Pilgrim Baxter, Pilgrim and Baxter violated Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a); Section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b); and Rule 10b-5, 17 C.F.R. § 240.10b-5 thereunder. FOURTH CLAIM Violations of Section 204A of the Advisers Act 49. Paragraphs 1 through 48 are realleged and incorporated herein by reference. 50. As a result of the conduct described herein, defendant Pilgrim Baxter violated Section 204A of the Advisers Act, 15 U.S.C. § 80b-4a, and defendant Baxter aided and abetted that violation, in that, while acting as an investment adviser, Pilgrim Baxter failed to establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of such investment adviser's business, to prevent the misuse of material, nonpublic information by such investment adviser or any person associated with such investment adviser. Pilgrim Baxter failed to take adequate steps to detect and deter short-term trading of PBGH funds by its portfolio managers and other investment professionals who had access to nonpublic information regarding, among other things, current portfolio holdings, valuations and transactions not readily available to all fund shareholders. Accordingly, defendant Pilgrim Baxter violated, and defendant Baxter aided and abetted Pilgrim Baxter's violation of, Section 204A of the Advisers Act, 15 U.S.C. § 80b-4a. I. Issue an injunction permanently restraining and enjoining defendants Pilgrim, Baxter and Pilgrim Baxter from violating Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a); Section 10(b) of the Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5. II. Issue an injunction permanently restraining and enjoining defendants Pilgrim, Baxter and Pilgrim Baxter from violating Sections 206(1) and 206(2) of the Advisers Act, 15 U.S.C. §§ 80b-6(1) and 80b-6(2); or, alternatively, issue an injunction permanently restraining and enjoining defendants Pilgrim and Pilgrim Baxter from violating, and defendant Baxter from aiding and abetting violations of those same provisions. III. Issue an injunction permanently restraining and enjoining defendant Pilgrim Baxter from violating, and defendant Baxter from violating or aiding and abetting violations of, Section 204A of the Advisers Act, 15 U.S.C. § 80b-4a. IV. Issue an injunction permanently restraining and enjoining Pilgrim and Baxter from acting as an officer, director, member of any advisory board, investment adviser, or depositor, or as principal underwriter of an open-end company, unit investment trust or face-amount certificate company, pursuant to Section 36(a) of the Investment Company Act, 15 U.S.C. § 80a-35(a), as a result of the violations set forth herein. V. Order defendants to disgorge the unjust enrichment that they derived from the activities set forth in this Complaint, together with prejudgment interest. VI. Order defendants to pay civil penalties pursuant to Section 20(d) of the Securities Act, 15 U.S.C. § 77t(d); Section 21(d)(3) of the Exchange Act, 15 U.S.C. § 78u(d)(3); and Section 209(e) of the Advisers Act, 15 U.S.C. 80b-9(e), in an amount to be determined by the Court. VII. Order such other and further relief as the Court may deem just and appropriate.
http://www.sec.gov/litigation/complaints/comp18474.htm
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