UNITED STATES OF AMERICA
In the Matter of
HAROLD J. BAXTER,
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
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").
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.
On the basis of this Order and Respondent's Offer, the Commission finds1 that:
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.
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
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.
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.
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.
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.
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.
17. As a result of the conduct described above, Baxter:
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.
19. Distribution of Disgorgement and Penalty. Baxter shall comply with the following undertakings:
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.
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
D. Respondent shall comply with the undertakings enumerated in Section III.19-20, above.
By the Commission.
Jonathan G. Katz
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