The Securities and Exchange Commission yesterday announced the filing of a civil injunctive action in the United States District Court for the Eastern District of Pennsylvania against Gary L. Pilgrim, of Malvern, Pa., Harold J. Baxter, of Berwyn, Pa., and Pilgrim Baxter & Associates, Ltd. (Pilgrim Baxter), a registered investment adviser headquartered in Wayne, PA, charging them with fraud and breach of fiduciary duty in connection with market timing of the PBHG Funds. Pilgrim was the President, Chief Investment Officer and Director of Pilgrim Baxter & Associates, and the President of the PBHG Funds. Baxter was the CEO and Chairman of Pilgrim Baxter & Associates, and the Chairman and trustee of the PBHG Funds and the PBHG Insurance Series Fund. Both Pilgrim and Baxter resigned from each of these positions on Nov. 13, 2003.
The Commission’s action is being brought contemporaneously with an action in New York State Supreme Court by the New York Attorney General, with whom the Commission has coordinated its efforts in this matter.
“Gary Pilgrim and Harold Baxter failed to uphold their end of the bargain with the mutual fund investors who entrusted them with their hard-earned savings,” said Stephen M. Cutler, Director of the SEC’s Division of Enforcement. “The allegations in our complaint describe a course of conduct that was unethical, illegal and just plain wrong. Pilgrim Baxter’s mutual fund investors deserved much better; their trust was abused.”
The Commission’s complaint alleges that the defendants permitted a hedge fund in which Pilgrim and his wife had a substantial interest, Appalachian Trails, to engage in market timing of the high profile Growth Fund that Pilgrim himself managed. The complaint also alleges that Baxter provided non-public PBHG Fund portfolio information to a close friend in the brokerage business, who was president of Wall Street Discount Corporation, a registered broker-dealer. The friend then passed this information to Wall Street Discount customers who used the portfolio information to market time the PBHG funds and to exercise hedging strategies through other financial and brokerage institutions.
According to the complaint, the defendants were aware of the impact of excessive short-term trading on a portfolio manager’s ability to effectively manage the assets of the funds and adopted and published a limitation of shareholder exchanges out of PBHG funds and into its cash management fund to four exchanges per year. Notwithstanding the published limitation of four exchanges per year, Appalachian Trails and Wall Street Discount, along with more than two dozen others, are alleged to have engaged in extensive exchanges in and out of the PBHG funds with the defendants’ knowledge and consent. This large-scale abuse peaked with timing assets of close to $600 million, and continued into the Summer of 2001. At that point, the defendants halted trading by all of the timers save Appalachian and Wall Street Discount, and redeemed their shares. These latter two were permitted to continue their trading through the end of 2001. Neither Pilgrim nor Baxter disclosed to the Board of Pilgrim Baxter, the Board of Trustees of the funds, or fund shareholders, that Pilgrim had an extensive financial interest in Appalachian and that Appalachian had been permitted to implement its trading strategy in PBHG funds. In 2000 and 2001, Appalachian profited by more than $13 million from its trading, $3.9 million of which was Pilgrim’s share.
The Commission has charged Pilgrim, Baxter and Pilgrim Baxter & Associates with violations of Section 17(a) of the Securities Act of 1933; Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 there under; and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940. The complaint also charges Pilgrim Baxter & Associates with violating Section 204A of the Advisers Act, and Baxter with aiding and abetting those violations. The complaint seeks permanent injunctive relief, disgorgement, prejudgment interest and civil penalties, and also seeks that Pilgrim and Baxter be permanently enjoined from acting in certain enumerated positions with an investment company pursuant to Section 36(a) of the Investment Company Act of 1940.