NASD announced that it has fined First Allied Securities, Inc. of San Diego $408,000 for facilitating the deceptive efforts of three hedge fund customers to engage in improper market timing transactions. NASD also ordered First Allied to pay approximately $326,500 to reimburse the affected funds.
NASD suspended Gary Ferraro, a former First Allied salesman located in Chicago and the broker for the three customers, for nine months and fined him over $136,700. NASD found that between November 2001 and July 2003, first at another firm and then at First Allied, Ferraro negotiated or authorized so- called “sticky asset” deals with two mutual fund advisors that enabled two hedge fund customers to execute more mutual fund trades than allowed in the funds’ prospectuses. Under these secret arrangements, Ferraro’s customers agreed to invest millions of dollars on a long-term basis in one mutual fund complex (the “sticky” money) in exchange for the opportunity to market time millions of dollars in other funds in the same fund family.
For example, NASD found that in one of Ferraro’s deals, a customer invested $1.9 million in long-term assets in one mutual fund in exchange for the opportunity to market time up to $1.9 million in another fund in the same complex. During a six-month period, the customer engaged in 20 exchanges, well in excess of the four exchanges out per year allowed by the prospectus, thereby generating illicit profits of more than $190,000.
In addition, Ferraro and First Allied enabled another client to use related accounts to evade attempts by a mutual fund complex to restrict the customer’s trading. Specifically, Ferraro opened an account for a client who proceeded to execute market timing trades in one mutual fund family. After the fund restricted trading, Ferraro opened two related accounts for the same beneficial owner, one of which was funded indirectly by a transfer of $4 million from the restricted account. Ferraro, through employees who reported to him, executed market timing trades in the two accounts in violation of the fund prospectus limits, thereby allowing the customer to earn approximately $110,000 in illicit profits.
NASD’s investigation showed that before hiring Ferraro, First Allied was aware that his customers were engaged in market timing. In fact, the investment advisor to one mutual fund complex advised an officer of First Allied that it had a special market timing arrangement with Ferraro that it did not offer to investors generally. The advisor also told First Allied that “working on this side of the business is something that most fund groups do not like to discuss openly.” Despite this knowledge, First Allied failed to implement a supervisory system designed to monitor the activity of Ferraro and the people who worked for him.
In settling with NASD, First Allied and Ferraro neither admitted nor denied the allegations, but consented to the entry of NASD’s findings.