Several years ago, Prudential Securities was charged with fraud for late trading. This was the first major brokerage house to be charged with the illegal practice of buying mutual funds after hours. The regulators who accused Prudential Securities charged them with carrying out a large-scale, late-trading scheme that involved more than 1,212 trades that were valued at a remarkable $162.4 million. These trades were placed after hours in order to benefit favored hedge funds. The complaint did not contain information regarding any profits that were protected by the scandal. The regulators who accused Prudential stated that Prudential should have noticed the considerable number of trades that were being placed after 4 p.m. and should have begun an internal inquiry. However, the complaint stated that Prudential possessed “no internal supervisory procedures” to detect trades placed after hours. Market timing, often done in conjunction with late trading, involves rapid in and out trading of a mutual fund designed to take advantage of delays in marking up prices of securities in the funds. By buying before the markups and selling quickly after them, Prudential traders realized quick profits for the firm’s clients at the expense of others. A group of managers and top-producing brokers were charged by the SEC and/or state in separate civil actions related to market timing. The firm denied all wrongdoing. Normally, orders to buy funds after 4 p.m. should be filled at the price set the next day. In late trading, which is illegal, orders instead get the same day’s 4 p.m. price, enabling investors to react to news a day ahead of other investors. In order to accomplish late trading, the complaint stated that Prudential clients would engage in the following activities: Prudential clients would submit a list of potential trades to brokers before the 4 p.m. deadline by fax, e-mail, or telephone. After 4 p.m., clients notified Prudential which of the long list of trades it wished to execute. Prudential brokers would take the original order, cross out the trades the client didn’t want to execute, and then forward the order to the firm’s New York trading desk. The time stamp on the fax would often deceptively reflect the time it was received originally, not the time that the client confirmed the order. For example, in just one afternoon, at 4:58 p.m., Prudential’s New York office executed more than 65 mutual fund trades, for a total of $12.98 million. According to the complaint, Prudential did nothing to substantiate the orders that were received before 4 p.m. In early 2003, the brokerage firm issued a policy change requiring branch managers to initial a cover sheet for trades before faxing them to New York. Lists of trades could be received at Prudential’s New York trading desk as late as 4:45 p.m. Accusations against the firm state that, “The orders were never rejected and were always executed at same-day prices.” The complaint further stated that Prudential also allowed the brokers involved in the market-timing and late-trading scheme to have dedicated wire-room personnel to execute trades. It has been suggested that the brokers compensated the wire-room employees for their efforts by sharing year-end bonuses. The state alleged that Prudential also authorized one broker to obtain special software that gave the employee “electronic capacity to enter bulk mutual fund exchanges after 4 p.m.”* Questions Determine whether this case would be prosecuted as a criminal or civil offense, and state reasons to support your conclusion. Who are the victims of this late-trading scheme, and what losses do they incur?
Several years ago, Prudential Securities was charged with fraud for late trading. This was the first major brokerage house to be charged with the illegal practice of buying mutual funds after hours.
The regulators who accused Prudential Securities charged them with carrying out a large-scale, late-trading scheme that involved more than 1,212 trades that were valued at a remarkable $162.4 million. These trades were placed after hours in order to benefit favored hedge funds. The complaint did not contain information regarding any profits that were protected by the scandal.
The regulators who accused Prudential stated that Prudential should have noticed the considerable number of trades that were being placed after 4 p.m. and should have begun an internal inquiry. However, the complaint stated that Prudential possessed “no internal supervisory procedures” to detect trades placed after hours.
Market timing, often done in conjunction with late trading, involves rapid in and out trading of a mutual fund designed to take advantage of delays in marking up prices of securities in the funds. By buying before the markups and selling quickly after them, Prudential traders realized quick profits for the firm’s clients at the expense of others. A group of managers and top-producing brokers were charged by the SEC and/or state in separate civil actions related to market timing. The firm denied all wrongdoing.
Normally, orders to buy funds after 4 p.m. should be filled at the price set the next day. In late trading, which is illegal, orders instead get the same day’s 4 p.m. price, enabling investors to react to news a day ahead of other investors.
In order to accomplish late trading, the complaint stated that Prudential clients would engage in the following activities: Prudential clients would submit a list of potential trades to brokers before the 4 p.m. deadline by fax, e-mail, or telephone. After 4 p.m., clients notified Prudential which of the long list of trades it wished to execute. Prudential brokers would take the original order, cross out the trades the client didn’t want to execute, and then forward the order to the firm’s New York trading desk. The time stamp on the fax would often deceptively reflect the time it was received originally, not the time that the client confirmed the order. For example, in just one afternoon, at 4:58 p.m., Prudential’s New York office executed more than 65 mutual fund trades, for a total of $12.98 million.
According to the complaint, Prudential did nothing to substantiate the orders that were received before 4 p.m. In early 2003, the brokerage firm issued a policy change requiring branch managers to initial a cover sheet for trades before faxing them to New York. Lists of trades could be received at Prudential’s New York trading desk as late as 4:45 p.m. Accusations against the firm state that, “The orders were never rejected and were always executed at same-day prices.”
The complaint further stated that Prudential also allowed the brokers involved in the market-timing and late-trading scheme to have dedicated wire-room personnel to execute trades. It has been suggested that the brokers compensated the wire-room employees for their efforts by sharing year-end bonuses. The state alleged that Prudential also authorized one broker to obtain special software that gave the employee “electronic capacity to enter bulk mutual fund exchanges after 4 p.m.”*
Questions
Determine whether this case would be prosecuted as a criminal or civil offense, and state reasons to support your conclusion.
Who are the victims of this late-trading scheme, and what losses do they incur?
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