NEW YORK - The founders of the Pilgrim-Baxter fund family were charged by state and federal regulators Thursday with improper trading of their funds to benefit themselves and friends at the expense of longer-term shareholders.
The civil actions by the Securities and Exchange Commission and the New York attorney general against Gary L. Pilgrim and Harold J. Baxter of Pilgrim Baxter & Associates, which manages the PBHG fund family, come a week after both men were forced out of the company because of the improper trading.
It is the first time that fund company leadership has been directly charged in connection with illegal trading practices. Previously, regulators had taken action against two former Putnam Investments portfolio managers, as well as the firm, but Putnam's executives were not directly accused.
And Eliot Spitzer, the New York attorney general, told members of the Senate Banking Committee on Thursday that his office probably would bring criminal charges against some companies in especially egregious cases of mutual fund trading abuses.
Senators gave voice to their concerns during the hearing about several financial firms that are alleged to have repeatedly committed fund trading and marketing violations and to have considered any penalties for such conduct as a cost of doing business.
Spitzer told them, "it's fair to presume that there will be criminal cases brought." That could represent the "death penalty" for those firms, he said.
A criminal conviction against a company could put it out of business, as happened last year to giant accounting firm Arthur Andersen after it was convicted of obstruction of justice for destroying Enron audit documents.
Criminal charges would go beyond the spate of civil actions that Spitzer, other state regulators and the SEC have been lodging against big mutual fund and investment firms in recent weeks.
Spitzer and SEC enforcement director Stephen Cutler, who appeared with him, acknowledged yet played down their recent public differences over pursuit of fund trading abuses and the SEC's civil settlement accord with big fund company Putnam Investments.
Cutler said it was time for state and federal regulators to put their differences over the Putnam case aside. "We are working aggressively to clean up the mutual fund abuses that we've seen," he said.
Cutler also defended the SEC's record against widespread criticism for failing to detect the abuses now shown to be permeating the industry, saying that the agency's program for inspecting fund companies was "severely underfunded" - with about 350 examiners to scrutinize some 8,000 companies. "It's certainly not been a lack of will," he testified.
The regulators spoke as their representatives charged Pilgrim and Baxter. According to the complaint, the trading arrangements netted those involved more than $13-million in profits, including $3.9-million for Pilgrim alone. "The top managers of this mutual fund lost their ethical compass and were unable to distinguish between what was in their shareholders' interest and their own interest," Spitzer said in a news release.
The two men and their company are charged with committing fraud on federal and state levels, as well as breaching their fiduciary duty to investors. Authorities said they will seek restitution for investors, but did not specify what fines or penalties would be sought.
A call to a Pilgrim Baxter & Associates spokesman seeking comment was not returned.
This is the latest development in the scandal rapidly spreading across the fund industry that long prided its untarnished reputation. Dozens of fund companies have been subpoenaed by the SEC and Massachusetts, New York and other state regulators amid reports of widespread improper trading.
Putnam and Canary Capital, a hedge fund operator, have agreed to settlements.
Authorities have also accused some individuals at Fred Alger & Co., Bank of America and Millennium Partners of improper trading. They also have indicated charges are likely against Alliance Capital for improper trading, as well as Richard S. Strong, the founder of the Strong mutual fund company, who has acknowledged making short term trades to benefit himself and his family.
Responding to the scandal, the House moved quickly Wednesday to adopt legislation cracking down on mutual fund abuses and providing more information for the 95-million Americans - half of all households - who invest in mutual funds. But lawmakers of both parties agree that substantial work is needed before a final reform measure can be enacted.
Treasury Secretary John Snow, who had cautioned earlier in the week that Congress should be careful that any legislation not drive up the cost of investing, said Thursday that the administration supported the basic thrust of the House-passed bill.
"Mutual funds are an extraordinarily important part of the financial structure of this country," Snow said in an interview with the Associated Press. "We must maintain trust and confidence in our capital markets and in the instruments of our capital markets like mutual funds."
The House measure, adopted nearly unanimously, would impose new curbs on fund trading abuses, make directors on company boards more independent from fund managers and require companies to disclose more information to investors about fees and fund operations.
It still needs approval in the Senate, where several different versions have been proposed. No action is expected before next year.
