NASD announced that it has fined Janney Montgomery Scott LLC, of Philadelphia $1.2 million for permitting improper market timing and related violations. In addition, NASD ordered the Philadelphia-based firm to pay nearly $1 million in restitution to the affected mutual funds.
NASD also suspended Kenneth Rosato — the former branch manager of Janney’s Brooklyn office and the broker responsible for the misconduct — for one year and fined him $370,000, which includes disgorgement of $185,000 in commissions he received as a result of the improper market timing activities. NASD also barred Linda Rosato, the former branch operations manager of Janney’s Brooklyn office and Kenneth Rosato’s sister-in-law, for refusing to testify in NASD’s investigation of this misconduct.
NASD found that from May 2000 through September 2003, Janney permitted two hedge fund customers to evade attempts by mutual fund companies to block or restrict their market timing transactions. The hedge fund accounts were customers of Kenneth Rosato. Rosato opened 19 different accounts for the two hedge funds and allowed them to engage in approximately 1,600 exchange transactions with mutual funds after receiving close to 200 block notices from those mutual funds prohibiting further trading.
NASD also found that Rosato also undertook a number of efforts to assist the hedge fund customers in evading the restrictions placed on market timing by mutual funds. Among other things, Rosato opened multiple accounts for the hedge funds to enable them to market time mutual funds without detection; used different broker numbers and different addresses in an effort to shield the true ownership of the accounts, and placed trades in related accounts to escape detection by the mutual funds.
Rosato also suggested deceptive strategies the hedge funds could use to evade attempts by mutual funds to restrict market timing — such as waiting a certain number of days after the initial purchase before market timing; limiting exchanges to a certain number per month; keeping transactions under a certain dollar amount, and recommending certain mutual funds to market time because those funds’ market timing monitoring efforts were viewed as being ineffective.
NASD’s investigation showed that Janney was aware that the hedge funds were engaging in market timing activity. The firm had received numerous notices from the mutual funds prohibiting future market timing by these customers. Despite this, the customers continued to engage in extensive market timing activity through Janney — earning approximately $1 million in profits at the expense of long-term investors in those mutual funds.
By permitting the market timing activities of the hedge fund customers, Janney and Rosato violated NASD’s rule requiring adherence to just and equitable principles of trade and high standards of commercial honor. Janney also failed to respond adequately to red flags that market timing was occurring, and failed to establish and maintain an adequate supervisory system to prevent or detect deceptive market timing practices.
NASD’s investigation uncovered other violations as well. NASD found that Janney did not have an adequate supervisory system to ensure an accurate response to regulatory inquires. In October 2003, Janney responded to an NASD request for information by stating that no one at the firm had promoted or otherwise encouraged market timing activities and that the author of the letter was not aware of communications between mutual funds and Janney regarding market timing. In fact, extensive market timing activities had occurred and the firm had received numerous communications from mutual funds concerning market timing. NASD found that Janney did not have a supervisory system or written procedures to ensure that it conducted adequate due diligence or made sufficient inquiry when responding to regulatory inquires. NASD found that Janney’s failure to establish an adequate supervisory system contributed to the firm’s inaccurate response to NASD’s request.
“NASD often begins its regulatory inquiries through written requests for information and relies upon the responses it receives to determine whether further review is necessary,” said Barry Goldsmith, NASD Executive Vice President and Head of Enforcement. “It is critical that firms have effective procedures in place for responding to regulatory inquiries and conduct a comprehensive and searching review before responding.”
NASD also found that Janney failed to create records reflecting the time of receipt of mutual fund orders and failed to establish and maintain an adequate supervisory system to detect and prevent late trading in mutual funds.
NASD’s investigation showed that in 2003, the firm’s records for more than 7,000 mutual fund orders that were processed after 4:00 p.m. contained no indication that the orders were actually received before 4:00 p.m.
In settling this matter Janney, Kenneth Rosato and Linda Rosato neither admitted nor denied the allegations, but consented to the entry of NASD findings.