The Securities and Exchange Commission filed a civil fraud action this week in federal court in Boston alleging that Columbia Management Advisors, Inc. and Columbia Funds Distributor Inc. allowed certain preferred mutual fund customers to engage in short-term and excessive trading, while at the same time representing publicly that it prohibited such trading. Columbia Management Advisors, Inc. is a registered investment adviser that manages Columbia mutual funds; Columbia Funds Distributor is a registered broker-dealer that is the principal underwriter and entity responsible for selling the funds. Both are subsidiaries of FleetBoston Financial Corporation.
According to the SEC's complaint, from at least 1998 through 2003, Columbia Funds Distributor secretly entered into arrangements with at least nine companies and individuals allowing them to engage in frequent short-term trading in at least seven Columbia funds, including international funds and a fund aimed at young investors. The SEC's complaint alleges that, in connection with certain of the arrangements, Columbia Distributor and Columbia Advisors accepted so-called "sticky assets" - long-term investments that were to remain in place in return for allowing the investors to actively trade in the funds. According to the complaint, after entering into these arrangements, the nine companies and individuals engaged in frequent short-term or excessive trading in at least sixteen different Columbia mutual funds. The SEC's complaint further alleges that executives of Columbia Funds Distributor entered into the arrangements, and that Columbia Management Advisors knew and approved of all but one of the arrangements and allowed them to continue despite knowing such short-term trading could be detrimental to long-term shareholders in the funds.
According to the SEC's complaint, both defendants acted improperly in entering and accepting the short-term trading arrangements, because they were contrary to disclosures made in the prospectuses used to sell the mutual funds. Specifically, six of the nine arrangements were entered into or continued after Columbia adopted prospectus disclosure for the mutual funds expressly stating that the funds did not permit short-term or excessive trading. The complaint further alleges that allowing the frequent traders' investments increased the size of the funds and resulted in increased advisory fees to Columbia Management Advisors and increased Columbia Distributor's revenues.
Stephen M. Cutler, Director of the SEC Division of Enforcement, said: "By putting their own financial interests ahead of their clients' interests, this investment adviser and broker-dealer violated their most basic duties and violated the trust that mutual fund shareholders placed in them. The Commission will continue aggressively pursuing companies which, like these defendants, allow harmful trading in their own mutual funds."
Peter H. Bresnan, Acting District Administrator of the SEC's Boston District Office, said:
"Columbia had one set of rules for small investors, and another secret set of rules for certain big money players. At the very same time that defendants assured investors that short-term and excessive trading was not permitted, they were in fact entering arrangements to allow exactly that type of trading, which allowed the defendants to profit while investors were harmed. Mutual fund companies that fail to put the interests of investors first can expect the Commission to act swiftly and forcefully against them."
The SEC's complaint alleges that the defendants had a duty to act at all times in the best interests of the Columbia mutual funds and to provide full and fair disclosure of all material facts to investors. According to the complaint, despite this duty, the defendants never disclosed to fund shareholders or to the independent trustees of the funds that particular investors were being allowed to make short-term trades in the funds, or that Columbia Management Advisors had a conflict of interest because the short-term trading arrangements served to increase its management fees.
The specific charges against the defendants in the federal court action are that they violated Section 17(a) of the Securities Act of 1933, Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, and Section 17(d) and Rule 17d-1 of the Investment Company Act of 1940. Additionally, the SEC's complaint alleges that Columbia Management Advisors violated Sections 206(1) and 206(2) of the Investment Advisers Act of 1940, and that Columbia Funds Distributor aided and abetted those violations; that Columbia Management Advisors violated Section 34(b) of the Investment Company Act; and that Columbia Funds Distributor violated Section 15(c) of the Exchange Act. The Commission is seeking injunctive relief, disgorgement, restitution of investor losses and civil penalties, and an order pursuant to Section 36(a) of the Investment Company Act enjoining Columbia Advisors from serving as an investment adviser to any registered investment company.
This week's actions reflect the coordinated efforts of the Securities and Exchange Commission and the New York Attorney General's Office, which brought a related action against the same defendants.
The Commission's investigation is continuing.