Prudential brokers are forced out

Five Prudential Securities stockbrokers in Boston and their manager were asked to resign Monday evening, following an internal investigation by their parent company, Wachovia Securities, into market timing in mutual-fund trading at the office.

The forced departures came after a month of intense scrutiny of Prudential's 100 Federal St. operation by state and federal regulators. The Massachusetts Securities Division, the Securities and Exchange Commission, and the National Association of Securities Dealers all have ongoing probes into allegations of improper mutual-fund trading by brokers in the office.

And in New York, Attorney General Eliot Spitzer is investigating Prudential as part of his national crackdown on market timing, a form of arbitrage in which traders hop in and out of mutual funds -- breaking fund rules -- to reap overnight profits on international market movements.

Among the brokers asked to leave Prudential this week was Martin J. Druffner, 34, the largest producer in the Boston office and one of the firm's highest performers in the country, according to recent company rankings.

In 2001, Druffner generated more than $1.7 million in commissions for Prudential, according to a company report, a copy of which was obtained by the Globe. Brokers take home about half of the money they bring into the firm. Brokers Justin F. Ficken, Marc J. Bilotti, John S. Peffer, and Skifter Ajro also resigned, as did Robert Shannon, the office manager.

Shannon's lawyer, Steven N. Fuller, a partner at Nixon Peabody, declined to comment. Michael Collora, a partner at Dwyer & Collora who is representing the brokers, said, "While they believe they adhered to company policies at all times, they have accepted this decision and have left the company."

Until last month, market timing was a little-known practice among ordinary investors. But amid the bull market of the late 1990s, it quietly became a lucrative business for a small cadre of young brokers, many of whom were catering to hedge funds and other savvy investors, according to Wall Street executives and academics who have studied the phenomenon.

Two former trade handlers in Prudential's Boston office, who spoke on condition of anonymity, said market-timing trades were a routine part of daily life for the past three years. Every day at 3:45 p.m., the former employees said, they would brace themselves for a crush of mutual fund trades. In the 15 frenzied minutes before the market's close, they said, they would be swamped with millions of dollars in orders to buy international fund shares.

With market timing, investors often buy shares in a foreign fund on a day when US stocks have jumped. They wait until the last possible moment, when US markets have nearly closed, in order to ensure the trading day ended on a positive note. With their trade, they are betting that European or Asian markets will rise, when they open, following the momentum of the US market. By morning, the traders know if their bet was correct, at which time they can sell to lock in their gains.

The trouble with market timing, fund executives and academics say, is that it effectively skims profits from mutual funds before that investor's money is ever put to work. Timing racks up expenses for the long-term investors, who own fund shares for years at a time.

And it can put strain on fund managers, who must put the short-term money into stocks or bonds, or leave it in cash, where over time it will be a drag on the fund's returns. Timers may seem invisible, but they cost average investors some $5 billion a year, according to Eric Zitzewitz, an assistant professor of economics at Stanford University's Graduate School of Business.

In depositions of current and former Prudential employees, the Massachusetts Securities Division has gathered testimony that confirms market timing was "routine and wide in scope," a state official involved in the investigation said.

Wachovia Securities spokesman Tony Mattera declined to discuss the specifics of the resignations. But Wachovia's compliance department, which assumed oversight for the merged Prudential-Wachovia brokerage as of July 1, has moved to tighten up the rules.

Early last month, Wachovia sent a compliance bulletin to all 12,000 brokers in 750 offices across the country, stating that market timing in funds is not permitted, and that the policy superseded any prior Prudential policy. Yesterday, Mattera said Richmond-based Wachovia "continually conducts internal reviews of its practices and compliance and takes appropriate action if necessary."

Wachovia assigned Dennis Schmidt, a highly regarded branch manager in its Conshohocken, Pa., office to oversee the Boston office temporarily. No permanent manager has been named yet, in part because the Prudential office will likely be combined with Wachovia's downtown office as part of the merger, company officials said.

Prudential Financial Inc., the Newark-based life insurer, retains a 38 percent stake in the merged brokerage group and has stated publicly that it is cooperating with the ongoing regulatory investigations. The company said in a Sept. 18 filing with the SEC that it's conducting its own internal review of mutual fund trading practices.

As previously reported by the Globe, Prudential had no formal policy on market timing until January of this year. Other major Wall Street brokers had banned market timing for at least a year by the start of 2003.

As the probes continue, higher-level Prudential executives may come under the spotlight, said David E. Marder, a former SEC lawyer in Boston who is now a partner at the Boston law office of Robins, Kaplan, Miller & Ciresi.

"It seems to me they've made a determination that there was wrongdoing, and they're seeking to distance themselves" from those employees, Marder said. But by letting go the manager as well, he said, Prudential may be indicating that the trading in the Boston office was not a simple case of a few rogue brokers breaking the rules.

Regulators will be hunting for clues as to whether executives in New York were aware of the market-timing activity in Boston, and turned their head because the business was generating significant revenue for the company.

"The company's going to claim these are bad apples and we got rid of them," Marder said. But, "The regulators always want the big fish."

Beth Healy can be reached at bhealy@globe.com.