Prudential probe focuses on who knew about trading

The Securities and Exchange Commission filed civil fraud charges yesterday against the five brokers and their manager, alleging they defrauded 68 mutual fund companies from 2001 through September of this year by repeatedly trading in and out of international funds and using deceptive means to outsmart the fund groups. And efforts to learn whether top executives of the company knew about the activity are underway.

"Our investigation is continuing," said Frank Huntington, senior trial counsel with the SEC in Boston, who is working on the case.

Meanwhile, the Massachusetts Securities Division said in its own complaint: "Senior Prudential executives knew and encouraged this activity and were reluctant to pass up the profits generated by courting multimillion-dollar accounts."

Prudential spokesman Jim Gorman declined to comment on the allegations, saying only: "We have been and continue to cooperate fully with the regulators."

According to the SEC's complaint, broker Martin J. Druffner, 34, and four of his colleagues made thousands of short-term mutual fund trades that generated commissions of more than $5 million for the firm in 2002 alone, and as much as $500,000 a month in 2003, even as Prudential was insisting that it did not permit market timing. Manager Robert E. Shannon assisted and approved the brokers' trades, the SEC alleged, and ignored hundreds of letters from mutual fund groups demanding that the brokers stop their abusive trading.

The brokers made most of their trades on behalf of eight hedge fund clients, according to the complaint. The largest of those was a foreign hedge fund that had more than $200 million in its Prudential account this year. The customer typically sent a fax to the Boston brokers each morning, detailing hundreds of potential fund trades it might want to make later that day. An executive of the hedge fund would then call one of the brokers around 3:30 p.m., a half-hour before the market's close, to "activate" certain of the trades it had laid out earlier, the SEC found.

"That's fraud, plain and simple," Stephen M. Cutler, the SEC's enforcement chief in Washington, D.C., said of the brokers in a statement.

Lawyers for the brokers and the manager, all of whom resigned under pressure in October, have denied any wrongdoing. Yesterday, Michael A. Collora, a lawyer with Dwyer & Collora in Boston who is representing the brokers, took aim at Prudential's executive suites, saying in a statement that market timing was "encouraged by their employers' top management personnel."

The brokers believed they were honest with the fund firms about their trading methods, Collora said. And yet the state regulators, going even further than the SEC, alleged that the brokers -- who included Justin F. Ficken, Skifter Ajro, John S. Peffer, and Marc J. Bilotti -- received thousands of cease-and-desist letters from mutual fund firms, threatening to stop doing business with the Prudential office's big producers unless they stopped buying and selling funds to reap quick profits. The brokers would use different names, customer names, and 62 different broker numbers -- in a breach of securities laws -- to disguise their identity when placing fund trades, the Massachusetts Securities Division found.

Michael J. Rice, the head of Prudential's brokerage operation during the period that the timing took place, last week left the firm, which in July merged with Wachovia Securities. Wachovia said Rice left because he did not want to move to the new Richmond headquarters.

Why so many fund groups, from Putnam Investments and The Hartford Mutual Funds to Phoenix Investment Partners Ltd. and even Prudential's own funds, objected to the relentless trading activity but failed to report it to regulators remains a mystery.

Indeed, regulators have trained their sights increasingly on the funds themselves as the national market-timing scandal has unfolded. Putnam, Janus, Strong, and Bank of America are among the fund groups that have been investigated by regulators.

And state regulators are still probing the role of wholesalers, or outside brokers for fund groups, in market timing. The Massachusetts Securities Division has subpoenaed wholesalers at Fidelity Investments, Morgan Stanley, and Franklin Templeton.

Michael A. Murray, a consultant in Southport, Conn., who used to run American Skandia's $47 billion investment group, said he started fighting market timing long before it became a household term. "We saw those problems coming early on. We kicked out all the market timers that we possibly could," Murray said. "You can aggressively fight this, do the right thing by your shareholders. But many people are either greedy or lazy and don't do it."

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