'Unfair' trading practice bared
Key witness testifies in mutual-fund case
www.nj.com - May 14, 2005 - BY MATTHEW FUTTERMAN - Star-Ledger Staff
Key witness testifies in mutual-fund case
NEW YORK -- "Nice insurance."
That is how former hedge fund manager Edward Stern liked to refer to his ability to trade mutual funds after the market officially closed, thanks to a special arrangement with Bank of America.
"In the event a significant company announces its earnings after 4 p.m., it can change the direction of the market," Stern said yesterday in a Manhattan courtroom, describing publicly for the first time how he essentially could play stock market roulette knowing where the ball would land.
"We could avoid market sell-offs that would occur because of news after 4 p.m., and participate in market rallies that occurred because of that news."
New York State Attorney General Eliot Spitzer has described Stern, a reclusive heir to his family's Hartz Mountain Industries fortune, as the key witness in the late-trading and market-timing scandal that rocked the once-staid mutual fund industry.
Stern, whose now-closed Canary Capital hedge fund was in Secaucus, testified at the trial of former Bank of America trader Theodore Sihpol. During nearly three hours of testimony, he spoke in precise, cold language about the late-trading arrangements that allowed Canary to pocket hundreds of millions of dollars in profits as the stock market entered a tailspin in 2001 and 2002.
Stern's testimony was part of a deal he cut with Spitzer that included a $40 million fine and full cooperation with the attorney general's investigation.
Stern wore a tailored gray suit and a dark blue tie as he strode into a setting most unfamiliar to a member of one of the country's wealthiest families -- a shabby criminal courtroom lit by a dozen half-broken fluorescent fixtures.
"In retrospect, it was unfair," Stern said, his hands clasped as he leaned forward in the witness chair, stealing tense glances at the jury but never at Sihpol. "But as a market participant and a hedge-fund manager, my job was to take the least amount of risk for the most gain."
Sihpol, a broker in Bank of America's private client services division, is the only person to be charged in the mutual funds investigation, which has produced $2.9 billion in fines, including a $675 million settlement with Bank of America. Sihpol faces up to 30 years in prison for grand larceny, securities fraud and falsifying business records.
To win a conviction, prosecutors must convince jurors Sihpol conspired to commit a crime, rather than simply institute what appeared to be a company-approved practice.
According to Stern's testimony, Sihpol was just one of many executives at Bank of America who helped lure Canary's and the Stern family's business by allowing him to trade after the stock market closed. In fact, Stern acknowledged that when Sihpol first reached him on a cold call in January 2001, the broker wanted only to help manage the Stern family's wealth. He knew almost nothing about the late trading of mutual funds, or another arrangement called market timing, in which investors are allowed to buy and sell mutual funds often even though they are supposed to be long-term investments, Stern testified.
Four months later, at two lengthy meetings at Bank of America's offices in New York, several of the bank's executives, including Sihpol's boss Mike Tierney, told how the bank could help him time and late-trade mutual funds, Stern said.
Sihpol was largely silent during those meetings, Stern testified. Meanwhile, a Bank of America technician, Matt Agugliaro, explained how they could install a computer terminal at Stern's office that would allow him to place his own trade orders as late as 6:30 p.m.
"Matt said we would be set up like a branch of Bank of America," said Stern, who claimed he and executives at the bank spoke openly about their arrangement.
For the next two years Sihpol's trading desk served as the communications center between Bank of America and Canary, though many others paid close attention to such an important client, according to Stern. He said he even met for coffee with bank Chairman Kenneth Lewis.
Then, in 2003, Charles Bryceland, the head of Bank of America's New York office, accompanied Sihpol to a meeting in Secaucus to discuss a new arrangement that might limit Stern's late trading.
By then, with hundreds of millions of dollars invested with Bank of America, Stern said, he was growing more uncomfortable with his late-trading advantage, but clearly not uncomfortable enough to stop, or to tell Sihpol he felt they were doing something wrong.
"I told them I was very happy with their level of service and I didn't want it to change," said Stern, who would close his hedge fund and return his investors' money in May 2003 as other mutual fund companies began to limit his late trading.
"Did you ever tell Ted Sihpol that your discomfort was growing?" asked Sihpol's defense lawyer, Paul Shectman.
"No," Stern said.