WASHINGTON -- Prudential Equity Group LLC (PEG), a broker-dealer subsidiary of Prudential Financial Inc. (Prudential), has entered into a deferred prosecution agreement in which PEG has admitted to criminal wrongdoing in connection with deceptive market timing trading in mutual fund shares dating back to 1999 and agreed to a payment of $600 million in fines, restitution and penalties.
The agreement was announced today by Deputy Attorney General Paul J. McNulty, chairman of the President's Corporate Fraud Task Force, who was joined by Director of the Division of Enforcement Linda Thomsen of the Securities and Exchange Commission (SEC), U.S. Attorney Michael J. Sullivan of the District of Massachusetts, and Peter Zegarac, Inspector in Charge of the U.S. Postal Inspection Service’s (USPIS) Boston District.
The Justice Department has also entered into a separate compliance agreement with PEG's parent company, Prudential. Under the terms of that compliance agreement, Prudential will also cooperate with the Justice Department in its ongoing investigation and will maintain policies and procedures relating to the integrity of the compliance functions across its various affiliated entities. The compliance agreement provides that the General Counsel of Prudential shall make periodic reports to the Prudential Board of Directors Audit Committee as to the appropriateness and effectiveness of the compliance plan. It also requires the General Counsel to provide the reports to the U.S. Attorney in the District of Massachusetts, along with a certification that the reports include all material information bearing on the effectiveness of the compliance plan.
According to a statement of facts accompanying the agreement, from 1999 through June 2003, a number of brokers at PEG's predecessor entity, Prudential Securities Inc. (PSI), engaged in a scheme to defraud mutual funds and their shareholders by using deceptive practices to place thousands of prohibited market timing trades on behalf of the brokers' clients, which were typically sophisticated hedge funds. The brokers were able to place these trades, thereby generating commissions for themselves and illicit profits for their clients, by manipulating trade information sent over the automated mutual fund trading system PSI used to communicate trades to mutual funds. Through the automated system, brokers were able to defeat efforts by the mutual funds to block their abusive market timing trading, by placing their trades in multiple accounts, often with multiple identities, to make it appear that the trades were coming from many different, unrelated brokers representing many different, unrelated clients.
“This is a great victory for the investing public,” said Deputy Attorney General McNulty. “The deceptive trading practices at Prudential were compromising the integrity of many mutual funds. Investors were dealt a bad hand by corporate con-men who stacked the deck against them. This resolution sends a strong message to predatory traders who dupe the system to reap millions in illegal profits."
U.S. Attorney Sullivan stated, “It is critically important for the public to have confidence in the integrity of our financial systems. The conduct at issue here was particularly troublesome, because it undermined the integrity and utility of the automated, standardized mutual fund trading system, a system that was created to bring greater efficiency to the trading of mutual funds.”
According to the statement of facts, on multiple occasions, the brokers' deceptive conduct came to the attention of senior management at PSI, who failed to stop the activity. Mutual fund companies repeatedly sent letters and e-mail to PSI imposing blocks on further market timing activity by the brokers. Some of these communications notified PSI that the brokers were engaged in deceptive practices to continue placing market timing trades.
Despite the communications by the mutual fund companies, PSI continued to issue brokers additional accounts for the clients engaged in timing; continued to issue additional broker identification or “FA” numbers to brokers that were used with the market timing clients; failed to utilize controls that could limit the brokers’ ability to engage in the deceptive practices; failed to comply with mutual fund companies’ requests that the market timing conduct of the brokers cease; misled some mutual fund companies by representing to them that PSI could and would stop the brokers from trading in their funds, and then failing to do so; failed to implement appropriate policies designed to prevent the brokers from engaging in the deceptive practices; and failed to impose any discipline upon any of the brokers even under circumstances where senior PSI managers were actually aware of the brokers’ deceptive conduct.
As part of the settlement, $270 million will be paid into the SEC Fair Fund, a fund set up to compensate victims of the fraudulent conduct. The $300 million criminal penalty will be paid directly to the U.S. Treasury and $25 million is being paid to the USPIS Consumer Fraud Fund to assist in future fraud detection and deterrence efforts. There is also a $5 million civil penalty being paid to the Secretary of the Commonwealth of Massachusetts.
In addition to the payment, PEG has also agreed to abide by a variety of terms and conditions for a period of five years, including cooperation with the Justice Department in its ongoing investigation of abusive and fraudulent trading in mutual fund shares.
To date, three individuals associated with the fraudulent trading at PEG's Boston branch office – Martin Druffner, Skifter Ajro and Robert Shannon – have pleaded guilty to wire and securities fraud charges. Druffner and Ajro are awaiting sentencing. Shannon was sentenced in July 2006.
This is an ongoing investigation, and the Justice Department and the U.S. Attorney’s Office in the District of Massachusetts are continuing their investigation of other individuals and entities for fraudulent trading in mutual funds.
The case was investigated by the U.S. Attorney’s Office in the District of Massachusetts, the USPIS, the SEC, and the Secretary of the Commonwealth of Massachusetts' Securities Division. It is being prosecuted by Assistant U.S. Attorney Jack Pirozzolo of the Economic Crimes Unit.
Since its creation by Executive Order in July 2002, the Corporate Fraud Task Force (CFTF) has spearheaded the administration’s effort to prosecute corporate malfeasance, protect the jobs of hard-working Americans, and restore confidence to the marketplace. Through the coordinated efforts of several federal agencies, the CFTF is sending a clear message that criminal activities in the corporate world will be swiftly and decisively prosecuted. By acting to deter fraud, the Task Force is also helping to restore shareholder and employee trust and demonstrating to the American people that the vast majority of corporate leaders are still honest and hardworking.