U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 19027 / January 10, 2005
SECURITIES AND EXCHANGE COMMISSION V. SCOTT B. GANN AND GEORGE B. FASCIANO, Defendants, Civil Action No. 3:05-CV-063-L (SAL) (U.S.D.C. N.D. Tex.) (Houston Division)
SEC FILES CIVIL FRAUD CHARGES AGAINST FORMER REGISTERED REPRESENTATIVES OF SOUTHWEST SECURITIES, BASED ON MUTUAL FUND MARKET TIMING AND LATE TRADING SCHEMES
Southwest Securities to Pay $10 Million, and Three Present or Former Managers to Receive 12-Month Supervisory Suspensions, in Settlement of Administrative Proceedings Based on Southwest Securities and Managers' Failure to Supervise Registered Representatives Who Committed Fraud
On January 10, 2005, the Securities and Exchange Commission ("SEC") announced that it filed a civil fraud action in U.S. district court in Dallas, against two former registered representatives of Southwest Securities ("Southwest"), a Dallas, Texas based broker-dealer and investment adviser, for allegedly engaging in a fraudulent market timing scheme. In that action, the SEC seeks injunctions, disgorgement of illicit profits, and civil money penalties against Scott B. Gann and George B. Fasciano, based on allegations that the two brokers carried out a fraudulent scheme to enable certain brokerage customers to engage in improper market timing of mutual funds.
The SEC and the New York Stock Exchange ("NYSE") also jointly announced the institution and settlement of enforcement proceedings against Southwest and three of its managers, Daniel R. Leland (formerly Southwest's president), Kerry M. Rigdon (formerly the director of Southwest's Private Client Group), and Kevin J. Marsh (formerly the manager of Southwest's downtown Dallas branch office). According to the SEC and NYSE, Southwest and the managers failed reasonably to supervise brokers in Southwest's downtown Dallas branch office who engaged in fraudulent mutual fund market timing schemes, late trading of mutual fund shares, or both. In settlement of the SEC and NYSE actions, Southwest has agreed to pay a total of $10 million, consisting of $2 million in disgorgement and an $8 million civil money penalty, and to undertake a number of measures to prevent future misconduct. The managers have agreed to settlements that include payments of disgorgement and civil money penalties totaling $275,000, as well as 12-month suspensions from association with a broker-dealer or investment adviser in any supervisory capacity. As part of the settlements, the firm and the managers neither admitted nor denied the SEC and NYSE findings.
"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 per se illegal, many mutual funds try to prevent it because it tends to harm long-term mutual fund shareholders. "Late trading" refers to the practice of placing orders to buy or sell mutual fund shares after market close at 4:00 ET, but at the net asset value ("NAV"), or price, determined at the market close. Late trading enables the trader to profit from knowledge of market moving events that occur after 4:00 ET, but are not reflected in that day's fund share price. Late trading is illegal.
According to the SEC and the NYSE, the fraudulent market timing schemes sought to circumvent trading restrictions that mutual fund companies imposed on Southwest brokers and accounts, by concealing from mutual fund companies improper market timing activities of Southwest brokerage customers. The SEC and NYSE found and alleged that more than 30 fund companies, representing hundreds of individual mutual funds, detected market timing trades by Southwest customers, and attempted to prevent further market timing by barring future trades, either in particular accounts or by a particular Southwest broker or branch office. In response, according to the SEC and the NYSE, Southwest brokers used "masking activities," such as multiple customer accounts, multiple broker identification numbers, and multiple branch office numbers, to disguise their customers' market timing trades and trick the fund companies into accepting the trades. For example, according to the SEC and NYSE, brokers in Southwest's downtown Dallas branch office executed trades for a single hedge fund adviser customer, using 21 accounts held by nine customer-affiliated entities, and using three broker identification numbers. According to the SEC and NYSE, the brokers used these masking tactics for the sole purpose of circumventing trading restrictions imposed by the fund companies. The SEC and NYSE found and alleged that those acts constituted a scheme to defraud, in violation of Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 promulgated thereunder.
The SEC and the NYSE also found that the managers failed reasonably to supervise the brokers, by failing to investigate or respond appropriately to red flags that should have alerted them to the brokers' improper conduct. According to the SEC and NYSE findings, the red flags included hundreds of notices, warnings, complaints and trading restrictions ("block notices") sent by mutual fund companies in response to the brokers' mutual fund market timing activities, and also included the brokers' requests for multiple account numbers per customer, and for additional broker identification numbers. The SEC and NYSE also found that Southwest failed to implement procedures designed to detect and prevent late trading. Section 15(b) of the Exchange Act authorizes the SEC to institute enforcement proceedings based on such supervision failures.
According to the NYSE and the SEC, Southwest also violated Rule 22c-1 under the Investment Advisers Act of 1940, which contains prohibitions against late trading. The SEC and NYSE also found that Southwest violated Section 17(a) of the Exchange Act and Rules 17a-3 and 17a-4 thereunder, which require broker-dealers to make and keep certain business records, including order tickets and electronic messages.
The SEC and NYSE acknowledged the assistance of the NASD in connection with the investigation.