SEC Charges Former CIBC Managing Director With Fraud for Role in Financing Unlawful Mutual Fund Trading
FOR IMMEDIATE RELEASE
Washington, D.C., Feb. 3, 2004 — The Securities and Exchange Commission instituted enforcement proceedings against Paul A. Flynn, a former managing director of Canadian Imperial Bank of Commerce (CIBC), for his role in providing financing to hedge funds he knew were engaged in unlawful market timing and late trading of mutual funds. Flynn, age 46, is a resident of Larchmont, New York.
Stephen M. Cutler, Director of the SEC's Division of Enforcement, said, "We are committed to punishing not just those who engaged in the trading, but also those who facilitated it. Bankers, by providing financing to their hedge fund clients, now join the list of brokers, traders, and mutual fund advisers who have been charged with participating in unlawful mutual fund trading."
Mark K. Schonfeld, Associate Regional Director of the SEC's Northeast Regional Office, said, "The SEC will not permit bankers to turn a blind eye to the fraud they finance. This case should alert management at financial institutions that they will be held directly accountable when they knowingly finance fraud."
The Division of Enforcement (the Division) alleges that from 2001 to 2003, Flynn arranged for certain hedge fund clients, including Canary Capital Partners, LLC, to receive financing from a CIBC subsidiary. Flynn negotiated and structured swaps and loan agreements that provided these hedge fund clients with leverage to trade in mutual fund shares. The Division alleges that this conduct was fraudulent because Flynn was aware that these hedge fund clients were engaged in unlawful mutual fund trading through an electronic trading platform operated by Security Trust Company, N.A. (STC).
According to the Division, Flynn made a due diligence trip to STC's offices during which he learned that the hedge funds used STC's trading platform for unlawful mutual fund trading. In a memorandum, Flynn described STC's "Same Day/Late Day Trading Platform and the benefits this proprietary platform brings to our Mutual Fund Market Timing Clients." First, Flynn's memorandum stated that, unlike standard platforms that require trades to be submitted before 4:00 p.m., clients using STC's platform "are able to submit trades for same day value" after 4:00 p.m. "based upon published Net Asset Values (NAVs)." According to Flynn's memorandum, "[A] pricing list is prepared by the company and submitted to our clients who are then able to run their timing models against actual closing prices instead of the previous day before they submit trades."
Second, Flynn's memorandum explained that STC utilized several strategies to reduce the chance that mutual funds would detect the hedge funds' market timing and late trading:
[T]he company allows our clients to submit trades in a number of methods to reduce the chance that they would appear to be timing a specific mutual fund. The different types of investing are as follows: 1) Traditional account specific fund investing keeping account balances small; 2) Using a number of multiple legal vehicles (i.e. different Tax ID numbers) they rotate the ownership of the mutual fund transferring balances between related accounts; 3) Piggy backing non-12(b)1 accounts (i.e. 401K etc.) To invest in pools of funds on a net basis as specific ownership is not known by the fund; and 4) Piggy backing 12(b)1 accounts w[h]ere a specific agreement is made with a broker to include the additional fund investments…
Thus, the Division alleges, Flynn was aware that by trading through STC, the hedge funds, and others were able to engage in late trading and to use deceptive means to evade the mutual funds' efforts to detect and prevent market timing.
On Nov. 25, 2003, the SEC announced an action against STC and three former executives, arising from their participation in mutual fund late trading and market timing schemes. On December 9, 2003, Nicole McDermott, former vice president of corporate services at STC, and one of the defendants in the STC action, pleaded guilty in a related criminal action in a New York State court.
The specific charges against Flynn are that he willfully aided and abetted and caused violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Rule 22c-1 promulgated under Section 22(c) of the Investment Company Act of 1940. The Division is seeking civil penalties, disgorgement and other relief, which may include permanently barring Flynn from the securities industry.
Stephen M. Cutler 202-942-4540See Also: In the Matter of Paul A. Flynn: Release No. 33-8360
Mark K. Schonfeld 646-428-1650