S.E.C. v. Pimco Advisors Fund Management LLC
| Decision Date | 22 October 2004 |
| Docket Number | No. 04 Civ. 3464(VM).,04 Civ. 3464(VM). |
| Citation | 341 F.Supp.2d 454 |
| Parties | SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. PIMCO ADVISORS FUND MANAGEMENT LLC, Pea Capital LLC f/k/a Pimco Equity Advisors LLC, Pimco Advisors Distributors LLC, Stephen J. Treadway, and Kenneth W. Corba, Defendants. |
| Court | U.S. District Court — Southern District of New York |
Nicolas Morgan, Adam Schneir, U.S. Securities and Exchange Commission, Los Angeles, CA, for plaintiff.
Alan Levine, Kronish Lieb Weiner & Hellman, L.L.P., Richard Mark Strassberg, Goodwin Procter LLP, New York City, for defendants.
DECISION AND ORDER
Defendants Stephen J. Treadway ("Treadway") and Kenneth W. Corba ("Corba") have each moved to dismiss the Complaint filed against them by the Securities and Exchange Commission ("SEC") in this action. For the reasons discussed below, the Court denies Treadway's motion in its entirety, and denies Corba's motions to dismiss all claims except for those alleging primary violations of Section 10(b) of the Exchange Act and Section 34(b) of the Investment Company Act. Corba's motion to dismiss these two claims are granted without prejudice.
Treadway and Corba were, until their recent resignations, executives with several corporate entities within the PIMCO family of mutual funds, PIMCO Advisors Fund Management LLC ("PAFM"), PIMCO Advisors Distributors LLC ("PAD"), and PEA Capital LLC ("PEA") (collectively, the "PIMCO Entities"). Treadway was the CEO of PAFM and PAD, as well as the Chairman of the Board of Trustees for the PIMCO Funds: Multimanager Series ("PIMCO Funds"). Corba was CEO of PEA, which acted as an advisor to the PIMCO Funds, as well as manager of two of the PIMCO funds, the PIMCO Growth Fund and the PIMCO Select Growth Fund, that played a role in the scheme alleged by the Complaint.
The SEC brought the instant enforcement action by reason of an alleged arrangement that Treadway and Corba entered into, on behalf of several of the PIMCO Entities, with Canary Capital Partners LLC ("Canary"), a firm that specialized in a practice known as "market timing" during the period at issue. Mutual fund market timing is a form of arbitrage activity that takes advantage of small short-term fluctuations in mutual fund prices. In order for a market timing firm to achieve substantial gains using the strategy, it must be able to quickly cycle its investments into and out of the targeted funds, engaging in what are known in the industry as "round trips."
While market timing can be a successful strategy for individual investors and is not itself illegal, it can also harm investors in a mutual fund that permits market timing by increasing trading and brokerage costs, as well as tax liabilities, incurred by a fund and spread across all fund investors. The quick pace of investments and redemptions associated with market timing may also hinder the ability of mutual fund managers to act in the best interests of fund investors who seek to maximize their long-term investment gains. It would make little sense for a fund manager to invest in assets with significant long-term potential but high short-term volatility if a market timer's redemptions could force the quick sale of fund assets. See, e.g., First Lincoln Holdings, Inc. v. Equitable Life Assurance Soc'y, 164 F.Supp.2d 383, 390-94 (S.D.N.Y.2001) (); Alan R. Bromberg and Lewis D. Lowenfels, 6 Bromberg & Lowenfels on Securities Fraud and Commodities Fraud §§ 16.1-12 (2d Ed.2004) (hereinafter, "Bromberg & Lowenfels") (describing the use and abuse of market timing and a related practice, late trading in mutual funds, within the mutual fund industry); Compl. ¶ 46 ().
The potential for market timing to harm the interests of mutual fund investors has led many mutual funds, including the PIMCO Funds, to adopt policies intended to limit market timing within their funds. According to the Complaint, PAD, on behalf of the PIMCO Funds, froze hundreds of accounts, sent warning letters to dozens of registered representatives, and took other measures intended to curb or eliminate the use of market timing in PIMCO mutual funds. The Complaint alleges that Treadway himself was responsible for curbing market timing within the PIMCO funds through his role as CEO of PAD and his supervision of PAD's "timing police." (Compl. ¶ 24.)
PIMCO, through its public communications to investors, made clear that it intended to minimize market timing activities within the PIMCO funds. According to the Complaint, the prospectuses published by the PIMCO Funds in November 2001 and February 2002 contained the following disclosure concerning market timing:
The Trust reserves the right to refuse exchange purchases, if, in the judgment of PIMCO Advisors, the purchase would adversely affect a Fund and its shareholders. In particular, a pattern of exchanges characteristic of "market-timing" strategies may be deemed by PIMCO Advisors to be detrimental to the Trust or a particular Fund. Currently, the Trust limits the number of "round trip" exchanges an investor may make.... The Trust has the right to refuse any exchange for any investor who completes (by making the exchange back into the shares of the originally purchased Fund) more than six round trip exchanges in any twelve-month period. Although the Trust has no current intention of terminating or modifying the exchange privilege other than as set forth in the preceding sentence, it reserves the right to do so at any time.
(Id. ¶ 39.) Similar language was contained in all fund prospectuses issued between November 2001 and 2003, and other publications, including shareholders' guides and Statements of Additional Information accompanying prospectuses, contained warnings against market timing.
The SEC alleges that Treadway's and Corba' actions with respect to Canary contrasted sharply with the market timing policies articulated in the PIMCO Funds' public disclosures and implemented by the PIMCO timing police. Specifically, Treadway and Corba personally negotiated an arrangement with Canary allowing Canary to engage in market timing activities within certain PIMCO funds. The negotiations began in late 2001 when broker representatives contacted Corba on Canary's behalf, and concluded in January 2002, when Treadway personally approved the arrangement. The original arrangement granted Canary up to $100 million in market timing capacity in the PIMCO Growth, Target, and Innovation Funds to be exchanged in up to four round trips per month, provided that Canary's holdings could not exceed more than three percent of any fund's assets. In exchange, Canary agreed to place "sticky assets," i.e., long-term investments, equal to twenty-five percent of the amount of timing capacity it used into a fourth PIMCO Fund, the PIMCO Select Growth Fund. Thus, under the proposed arrangement, investors in one fund, the Select Growth Fund, would obtain a significant benefit, while investors in the Growth, Target, and Innovation Funds would bear all of the costs of Canary's market timing activities.
According to the SEC, Canary's actual market timing practices varied somewhat from the terms of the original arrangement. The portfolio manager of the Innovation Fund forbade Canary from market timing within that fund after Canary had engaged in a first round-trip exchange using the fund. Canary found ways around this limitation on its market timing activities, in part by investing $2 million in a hedge fund managed by the PIMCO Entities, the PIMCO Equity Advisors Horizon Fund LP (the "Horizon Fund"), in exchange for receiving $5 million in market timing capacity in yet another PIMCO Fund, the Opportunity Fund. Canary also allegedly engaged in extremely aggressive market timing using the Growth and Target Funds, executing over twenty-eight round-trip exchanges in the Growth Fund, with a dollar volume of at least $1.8 billion, during a six-month period in 2002, and in over forty round-trip exchanges in the Target Fund, with a dollar value of over $2 billion, during a ten-month period in 2002. According to the SEC, Canary also benefitted from disclosure by PEA of nonpublic information concerning the portfolio holdings of several PIMCO funds. With this nonpublic "inside information," Canary was able to anticipate the daily changes in price of the funds that it market timed with a great deal of precision and essentially guarantee the success of market timing trades. See Bromberg & Lowenfels § 16.9 ().
The SEC asserts that while Canary's aggressive market timing practices quickly drew Treadway and Corba's attention, both failed to act quickly to stop them. Corba was informed as early as March of 2002 that Canary's practices were disruptive to several PIMCO funds, and Corba, Treadway, and others received e-mails in April of 2002 from PAD's timing police indicating that Canary's market timing practices were exceeding agreed-upon limits and causing significant trade settlement problems. In May of 2002, Corba sent an e-mail characterizing Canary's trading as "the most opportunistic but extreme form of market timing [he had] ever seen." (Compl. ¶ 53.) Despite their early recognition that Canary's practices were harmful to PIMCO investors, Treadway and Corba failed to take concrete steps to stop the timing practices until late 2002, and allowed Canary to continue market timing in PIMCO Funds until as late as May 2003. (Id. ¶¶ 56-57.)
The SEC also alleges that...
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