LexisNexis Corporate & Securities Law Community 2011 Top 50 Blogs

Bon mots

"You can observe a lot just by watching." Yogi Berra

"We do not distain to borrow wit or wisdom from any man who is capable of lending us either." Henry Fielding, Tom Jones

"In our complex society the accountant's certificate and the lawyer's opinion can be instruments for inflicting pecuniary loss more potent than the chisel or the crowbar." United States v. Benjamin, 328 F.2d 854, 862 (2d Cir. 1964)

Mutual Fund Frequent/Late Trader Barred, Ordered to Pay Disgorgement and Penalties Totaling $728,000

Gregory O. Trautman, Exchange Act Rel. 61167, December 15, 2009

Time since appeal – 1 year 9 months 20 days
Time since last brief – 1 year 6 months 24 days

Trautman was the CEO of a broker dealer. The ALJ found he schemed to defraud mutual funds through illegal late trading and fraudulent market timing of mutual fund shares on behalf of both customers and the firm. The Commission entered the following sanctions: a bar from associating with a broker-dealer; a cease and desist order; $608,000 of disgorgement, plus additional prejudgment interest; and a $120,000 penalty. Trautman's firm made $22.6 million in revenues from the scheme and mutual fund customers lost an estimated $102 million.

Late trading is the illegal and fraudulent practice of permitting mutual fund share orders received after 4 p.m. Eastern time when the market closes to receive that day's price instead of the next day's price. Frequent trading involves attempts to exploit pricing inefficiencies resulting from the fact that mutual fund prices are only calculated once at the end of the trading day. Although frequent trading is not per se illegal it violates the rules of most mutual funds that permit only a limited number of trades by investors. The practice harms long term shareholders and increases fund expenses. The opinion provides a detailed explanation of why both practices are harmful to investors and cites many of the Commission's significant cases in the area.

Trautman's firm actually established a mutual fund timing department. Many of the institutional clients of this department have been subject to civil or administrative cases. The firm developed a number of procedures designed to hide its trading activities from mutual funds. The Commission found that Trautman was personally involved in these activities and acted with scienter. It also found that Trautman aided and abetted the firm's violations.

The Commission took into account conduct that occurred before the limitations period in evaluating motive, intent and knowledge. As an evidentiary matter, it noted that it will not consider previous regulatory sanctions based solely on CRD printouts – instead it requires that the actual settlement records be introduced into evidence. The Commission also rejected Trautman's argument that no penalty or disgorgement should be imposed due to his financial condition. It noted that such a showing is only one factor that it will consider in determining monetary sanctions.