U.S. Securities and Exchange Commission
Litigation Release No. 18489 / December 4, 2003
Securities and Exchange Commission v. Mutuals.com, Inc., Connely Dowd Management, Inc., MTT Fundcorp, Inc., Richard Sapio, Eric McDonald, and Michele Leftwich, Civil Action No.303 CV 2912D (N.D.Tex.)
SEC Charges Dallas Investment Complex and Three of Its Officers with Defrauding Hundreds of Mutual Funds in Market Timing and Late Trading Scheme
On December 4, 2003, the Securities and Exchange Commission filed a civil securities fraud action in the United States District Court for the Northern District of Texas, against Mutuals.com, Inc., its CEO, its president, and its compliance officer, as well as two affiliated broker-dealer firms. According to the SEC's complaint, the defendants fraudulently helped institutional brokerage customers and advisory clients to carry out and conceal thousands of market timing trades and illegal late trades in shares of hundreds of mutual funds. The SEC initially detected the alleged misconduct during an examination of the Mutuals.com investment complex in October 2003.
The SEC asked the court to enjoin the defendants from further securities law violations, and also sought civil money penalties and disgorgement of illicit profits plus prejudgment interest. The Commission also sought, and the defendants consented to, the appointment of a Special Monitor to oversee the defendants' business operations, including the management of the Mutuals.com Trust mutual funds (formerly known as 1-800 MUTUALS Advisor Series), pending resolution of the civil litigation.
The SEC named the following individuals and entities as defendants in the action:
In its complaint, the SEC alleges that Mutuals.com, CDM and MTT facilitated thousands of market timing trades and late trades, at the direction of and with the full knowledge and approval of Sapio, McDonald and Leftwich. According to the complaint, the only "advisory services" Mutuals.com provided for its clients was advice on how to employ deceptive trading techniques to engage in improper mutual fund trades, as well as assistance in the implementation of those techniques and concealment of the illicit trading.
With respect to the defendants' market timing scheme, the SEC alleges that, between July 2001 and September 2003, hundreds of mutual fund companies and two clearing firms admonished Mutuals.com that its clients' and customers' market timing activity was improper, and, by September 2003, approximately 294 different mutual fund companies had banned or otherwise restricted Mutuals.com from trading in their shares. In response, according to the Commission's complaint, Sapio, McDonald and Leftwich devised and perpetrated a number of deceptive acts and practices to conceal their clients' market timing activities. Specifically, the Commission alleges that, whenever a fund tried to restrict timing activities, Mutuals.com and its principals used means such as: (1) formation and registration of two affiliated broker-dealers (CDM and MTT) through which they could continue to market time undetected; (2) changing account numbers for blocked customer accounts; (3) use of alternative registered representative numbers for registered representatives who were blocked from trading by mutual funds; (4) use of different branch identification numbers; (5) switching clearing firms; and (6) suggesting that their customers use third party tax identification numbers or social security numbers to disguise their identities, so that they could continue to trade in funds from which they had been banned.
"Market timing" refers to the practice of short term buying and selling of mutual fund shares in order to exploit inefficiencies in mutual fund pricing. Although market timing is not illegal, it may harm long-term mutual fund shareholders, and many mutual funds try to prevent market timing.
With respect to late trading, the SEC's complaint alleges that, at least during 2003, Mutuals.com and its affiliated broker dealers routinely received trading instructions from customers after 4:00 p.m. EST and executed those trades as if the trading instructions had been received prior to that time. According to the SEC, Mutuals.com and its affiliates attempted to conceal late trading activities by omitting portions of the trading information they were required to provide to clearing agents.
"Late trading" refers to the practice of placing orders to buy or sell mutual fund shares after market close at 4:00 p.m. EST, but at the net asset value (NAV), or price, determined at the market close at 4:00 p.m. EST. Late trading enables the trader to profit from market events that occur after 4:00 p.m. EST but that are not reflected in that day's price. Late trading is illegal.
The SEC alleges that, by way of the conduct alleged in the complaint: (i) each of the proposed defendants violated Section 17(a) of the Securities Act of 1933 ("Securities Act"); (ii) each of the proposed defendants violated, and aided and abetted their customers' and clients' violations of Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder; (iii) Mutuals.com, CDM and MTT violated Section 15(c)(1) of the Exchange Act; (iv) Sapio, McDonald and Leftwich aided and abetted those violations of Section 15(c)(1) of the Exchange Act; and (v) Mutuals.com, CDM and MTT violated Rule 22c-1 of the Investment Company Act of 1940 (which prohibits the purchase or sale of mutual fund shares except at a price based on the current NAV of such shares that is next calculated after receipt of a buy or sell order).