Peter C. Harvey, Attorney General
 
Bureau of Securities
Franklin L. Widmann, Chief
 
For Immediate Release:
March 15, 2005
For Further Information Contact:
Peter Aseltine (609) 292-4791

 

Attorney General Harvey Revokes Licenses of Three New Jersey Brokers;
Seeks Penalties for Their Deceptive Practices in Trading of Mutual Funds
as Agents of Ubs Paine Webber and Merrill Lynch

TRENTON – Attorney General Peter C. Harvey today announced that the New Jersey Bureau of Securities has filed an administrative complaint against three New Jersey-based financial advisers who allegedly defrauded mutual fund companies and their long-term shareholders in connection with hundreds of millions of dollars in market timing trades. This suit is further action by Attorney General Harvey stemming from the investigation behind the $10 million Merrill Lynch settlement announced last week.

The allegations concern trades made by the three financial advisers on behalf of a hedge fund, Millennium Partners, L.P., which was their primary client from 2000 though 2003, while they were employed first by UBS PaineWebber Inc., then Merrill Lynch Pierce Fenner & Smith Inc. The complaint filed by the Bureau of Securities in the Office of the Attorney General seeks civil monetary penalties from the three financial advisers, Christopher Chung of Edgewater, Kevin Brunnock of Fort Lee, and William Savino of Fort Lee. The Attorney General, through the Bureau, today revoked their registration to trade securities as broker-dealer agents in New Jersey.

The Defendants

The three financial advisers, known as the "CBS Group," sought to profit from market fluctuations by quickly trading in and out of mutual funds, skimming off short-term gains to the detriment of long-term investors. Because Merrill Lynch and the mutual funds had policies against market timing, the three financial advisers devised a variety of fraudulent schemes to conduct and disguise their trading on behalf of Millennium, the Bureau alleges. Merrill Lynch is cooperating with the Attorney General's Office in its prosecution of this case.

"These three financial advisers cheated small investors to benefit their large corporate client and to enrich themselves," said Attorney General Harvey. "They market timed mutual funds that were intended to provide relatively stable, long-term investments for ordinary people planning for their retirement or their children's college tuition. Most mutual funds prohibit market timing, because it siphons off short-term profits and makes funds more volatile. However, these financial advisers devised scheme after scheme to hide their conduct and defraud mutual funds and fund investors."

On March 8, Attorney General Harvey announced that he had reached a $10 million settlement with Merrill Lynch regarding the firm's failure to reasonably supervise the three financial advisers. Merrill Lynch agreed as part of the settlement to implement significant reforms to ensure better supervision of its financial advisers.

The CBS Group's Market Timing Activity

Shortly after the CBS Group was hired by Merrill Lynch in January 2002, supervisors warned the three financial advisers that they were violating the firm's policies against market timing. However, the three financial advisers continued to market time until they were fired in October 2003. The group's market timing for Millennium was a significant reason why the Paramus Complex of Merrill Lynch, which includes the Fort Lee office where the CBS Group worked, was ranked No. 1 in the country for revenues for the firm in the first quarter of 2002. Between January and April 2002, the CBS Group placed more than 3,700 trades on behalf of Millennium, many of which were held for less than five business days.

The CBS Group sustained and hid its mutual fund trading activity by what Chung proudly called "deviancy at its best" in one recorded phone call that is transcribed in the Bureau's complaint. The complaint can be viewed online, linked to this press release at www.njpublicsafety.com.

Many of the trades by the CBS Group, both at UBS Paine Webber and Merrill Lynch, involved mutual funds held as sub-accounts of variable annuity contracts, which are insurance products with an investment component.

In about one year of trading for Millennium at UBS Paine Webber, the CBS Group placed 12,953 trades in more than 350 mutual funds. Millennium made profits in at least 243 of those funds. In those funds where Millennium made profits, its gains totaled about $25 million.

While at UBS Paine Webber, the CBS Group also placed trades in at least 31 mutual fund sub-accounts, through at least 15 variable annuity contracts. In at least 27 of the sub-accounts, Millennium made profits, which totaled about $4.5 million.

At Merrill Lynch, the three financial advisers, and a fourth who was involved to a lesser degree, placed 12,457 trades for Millennium in at least 521 mutual funds and 63 mutual fund sub-accounts of at least 40 variable annuities. Millennium made profits in over half of the funds and fund sub-accounts. In those funds where Millennium made profits, its gains totaled about $60 million.

The investigation by the Bureau of Securities was conducted by Chief of Enforcement Richard Barry, Regulatory Attorney Ethan Silver and Investigators Julian Leone and James Monagle. Deputy Attorney General Anna Lascurain, Chief of the Securities Fraud Prosecution Section of the Division of Law, handled the case for the Attorney General.

The schemes used by the CBS Group included:

• offering mutual fund companies sticky assets – longer term investments in certain funds that generate fees for the mutual fund company – in exchange for market timing capacity in other funds;

• using multiple accounts in different names for the same client to split up trades and "fly under the radar" of the mutual funds; and

• deceptively transferring or "journaling" investments in funds from accounts at the investment firm to accounts at the mutual fund companies, then back to the investment firm to different accounts, in order to avoid fees and detection of market timing.

Merrill Lynch Settlement Reforms

Under the settlement announced last week, Merrill Lynch and the Merrill Lynch Insurance Group Inc. will implement new procedures to maintain, as a required "book and record" under New Jersey and federal securities laws, records of all client reallocation requests involving mutual funds held as sub-accounts of annuity products of outside insurance carriers. Neither firm previously recorded those requests, despite state and federal rules requiring financial advisers to record every trade of a security for a client. Without records, those transactions could not be properly supervised. The lack of record-keeping for such transactions is an industry-wide issue.

Variable annuity and corporate-owned life insurance contracts were purchased in the names of principals and employees of Millennium to meet the requirement that such contracts be purchased for a "natural person," but the economic reality and purpose of the contracts was to establish vehicles for Millennium to stealthily gain trading capacity for market timing.

The three defendants face potential civil monetary penalties of not more than $10,000 for a first violation of the New Jersey Securities Law and not more than $20,000 for each additional violation. Each and every act that they committed in furtherance of their fraudulent conduct is a separate violation of the Securities Law.

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