Hedge fund adviser Pentagon Capital Management PLC (PCM) and Lewis Chester, PCM’s Chief Executive Officer, “egregiously violated” the federal laws and were found guilty of securities fraud by United States District Judge Robert W. Sweet of the Southern District of New York. PCM is based in the United Kingdom.
In his opinion issued on February 14, 2012, the judge found that the defendants had indulged in a systematic operation to cheat mutual funds and their shareholders through late trading and deceptive market timing during the period from February 2001 through September 2003, using broker-dealer Trautman Wasserman & Company Inc.
The profits from this scheme amounted $62 million and accrued to PCM’s advisory client, Pentagon Special Purpose Fund Ltd., an international business company incorporated in the British Virgin Islands, while PCM and Chester earned performance and management fees for managing the Fund.
According to the SEC complaint, PCM regularly traded U.S. mutual funds through a number of broker-dealers in the United States and during the above period PCM and Lewis Chester systematically late-traded these funds. The M.O. was to place orders to buy, redeem or switch mutual fund shares after the normal cut-off time of 4:00 p.m. Eastern Time, the market close, but still obtaining that day’s mutual fund price. The defendants could thus take advantage of market events that occurred after the 4:00 p.m. deadline, while paying the price prevailing at 4:00 p.m.
The SEC also complained that the defendants used deceptive methods to cloak their market timing activities from mutual funds by opening multiple accounts at various broker dealers, and distributing the total volume of their trades among these accounts. If a mutual fund detected market timing on any account, the defendants would simply move on to another account and resume market timing.
Saying that the Defendants “intentionally and egregiously violated the federal securities laws through a scheme of late trading” and that the scheme was “broad ranging over the course of several years and in no sense isolated,” Judge Sweet enjoined the defendants from future breach of those legal provisions. He further held the Defendants and the Pentagon Fund liable to disgorge $38,416,500 being the profits from the fraudulent trades in mutual fund shares, and also prejudgment interest. Civil penalties of $38,416,500 were also imposed on the Defendants.