Fraud at Pimco Bond Unit Alleged

Authorities on Tuesday accused Pimco’s Newport Beach-based bond operation -- which had been untouched by the mutual fund scandal -- of letting a wealthy client rapidly trade its signature bond funds to the harm of regular investors.

New Jersey Atty. Gen. Peter C. Harvey sued Pimco’s parent, Allianz Dresdner Asset Management, and three affiliated firms, claiming they defrauded shareholders by allowing the Canary Capital Partners hedge fund to “market-time” stock and bond mutual funds.

Market timing -- or rapid-fire, in-and-out trades -- allowed Canary to net profit of more than $4 million from two bond funds alone, Pimco High Yield and Pimco Real Return, the complaint alleges.

Pimco, short for Pacific Investment Management Co., was notified by federal regulators last week that it could face civil charges for market-timing activity involving its New York-based stock funds. Tuesday’s action was the first to target the company’s bond funds, based in Newport Beach.

“With ordinary investors, Pimco’s market-timing police enforced the rules, but when it came to Canary, they said, ‘This is fine,’ ” Harvey said in an interview. “At the end of the day, small investors paid the price for this market-timing activity.”
Harvey said New Jersey would seek fines and restitution, with the amounts still to be determined.

Pimco called its arrangement with Canary “an isolated incident” and vowed to repay $1.6 million to the stock funds harmed by the short-term trading from October 2001 to May 2003.

As for the bond funds, Pimco spokesman Phil Neugebauer disputed the regulators’ analysis. He said shareholders weren’t harmed by the trading from January to September last year, and that it “occurred within the parameters of the funds’ prospectuses.”

Pimco High Yield, a junk bond fund with about $8 billion in assets, and Pimco Real Return, an inflation-indexed bond fund with $10 billion in assets, are available for a minimum $2,500 investment.

Neugebauer also noted that Pimco, unlike other firms under investigation, doesn’t explicitly prohibit market timing. Its fund prospectuses say only that the firm retains the “right to refuse” such activity.

Last week, Pimco sought to downplay the link to its Southern California-based bond operation, centerpiece of the nation’s fifth-largest fund company.

New Jersey’s complaint portrays an intricate relationship between Pimco and Canary, claiming that several of the fund giant’s executives on both coasts were aware of timing deals.

For example, Newport Beach-based portfolio manager David Hinman told a Pimco marketing executive in an Oct. 1, 2002, e-mail that a company bond fund could handle $20 million in market-timing activity a month, the complaint says.

The market timing of bond funds ended Sept. 11, according to the complaint. That was eight days after scandal engulfed the nation’s $7.4-trillion mutual fund industry when New York Atty. Gen. Eliot Spitzer accused New Jersey-based Canary of market timing and illegal “late trading” at four other fund companies.

New Jersey says that in early 2001, a “market timing consultant” introduced Canary to Pimco. Canary allegedly was granted $100 million in so-called timing capacity at three stock funds, Pimco Equity Advisors Target, Opportunity and Growth, in exchange for $25 million in long-term investments at another fund.

The arrangement provided easy profit for Canary and a source of investment capital for Pimco funds. But authorities say investors got a raw deal because the transaction costs of market timing cut into their returns.
Canary was allowed to make as many as 48 “round trips” in and out of the equity funds every 12 months, even though the funds’ prospectuses indicated that investors were limited to six round trips. In the year and a half that Canary was wheeling and dealing the stock funds, Pimco’s “market timing police” sent out more than 700 letters and e-mails to other investors after halting more than 1,700 trades that were deemed excessive, the complaint alleges.

“The pattern that is most disturbing to me is that you only seem to be interested in being in our funds for a day or two at a time -- perhaps the most opportunistic but extreme form of market timing that I have ever seen,” complained Kenneth Corba, managing director of subsidiary Pimco Equity Advisors, in a May 2002 e-mail to Canary’s broker, Brean Murray Inc.

Nonetheless, the trades continued for another year, according to the complaint. Altogether, Canary netted about $1 million in profit from trading one stock fund and avoided $11 million in bear market losses by being allowed to trade out of several other funds, the complaint claims.

The bond trading deal was launched soon after Hinman said the Pimco High Yield fund could handle $20 million in market timing a month, the complaint said. Pimco Vice President Scott Spalding then negotiated a deal with Canary’s timing consultant that called for an initial investment of $30 million in Pimco funds.