NASD Fines State Street Research Investment Services $1 Million for Market Timing Supervision Violations; Firm Ordered to Pay More Than $500,000 in Restitution
Washington, D.C.—NASD announced today that it fined State Street Research Investment Services, Inc. (SSR) $1 million for failing to prevent market timing of State Street Research mutual funds due to its inadequate supervisory systems. SSR also agreed to pay more than $500,000 in restitution to the individual State Street Research mutual funds to compensate the for losses attributed to the market timing activity. SSR, located in Boston, MA, distributes State Street Research mutual funds to NASD-regulated broker-dealers for sale to their customers.
NASD found that, from 2001 through August 2003, SSR's inadequate supervisory system improperly permitted the customers of at least one other securities firm, Prudential Equity Group, Inc., formerly known as Prudential Securities, Inc., to exchange (alternatively buy and sell) shares of State Street Research funds beyond the annual limits set forth in the prospectuses. The annual limits, typically six exchanges per year, were designed to limit market timing in the funds. Market timing is the frequent trading of mutual fund shares in order to take advantage of pricing inefficiencies or market movements.
"Market timing, in violation of prospectus limits, can dilute the value of fund shares, raise transaction costs and thus harm other fund shareholders," said Mary L. Schapiro, Vice Chairman of NASD. "When a firm is on notice, as SSR was, that its funds are being timed, the firm must respond quickly and effectively."
In its investigation, NASD found that by November 2001, SSR's operations personnel had reason to believe that the Boston office of Prudential Securities was engaged in market timing activities on behalf of its clients and that, among others, certain Prudential Securities customers had been able to exchange shares of State Street Research funds beyond the annual limits described in the applicable prospectus.
SSR was aware that a number of Prudential Securities' registered representatives engaged in deceptive conduct so that their customers could exchange funds in excess of prospectus limits. For example, if SSR sent "block letters" prohibiting customers from making future fund exchanges in an account because the customer had exceeded a fund's annual exchange limit, Prudential Securities' registered representatives would use a different account number for that customer in order to evade the block. This ensured the "blocked" customer would be able to continue to buy and sell shares of that fund.
NASD found that SSR's supervisory procedures and systems were not adequate to prevent and detect customers circumventing the block restrictions. The firm's written supervisory procedures and systems failed to provide for adequate follow-up to the "block letters" it sent to brokerage firms. Some customers of these firms were able, through the establishment of new customer accounts, to continue trading in SSR funds even after one of their accounts had been blocked. Moreover, SSR's systems and procedures were not able to ensure that accounts were blocked in a timely manner. In several instances, SSR sent "block letters" after the customer had already exceeded the fund exchange limits. The firm did not have an effective system for tracking and enforcing compliance with the "block letters."
In addition to fining the firm, NASD also required SSR to certify that it has disclosed all instances of fund trading that was inconsistent with the prospectus exchange limits and that it has implemented appropriate systems and controls with respect to market timing.
During its investigation, NASD also found that SSR failed to preserve and maintain internal e-mail communications relating to the firm's business as required by the federal securities laws and NASD rules. For example, the firm failed to retain all e-mails that were sent but later deleted by its employees.
In addition to paying a $1 million fine, SSR was ordered to pay more than $500,000 to the State Street Research funds to compensate them for losses resulting from the prohibited market timing during the period the three-year period ending December 31, 2003. The restitution payment will be apportioned among the affected State Street Research Funds.
In settling this matter, SSR neither admitted nor denied the charges.
While today's action resolves the matter with SSR, NASD's investigations into conduct relating to this case and other market timing violations continue. Investors can obtain more information and the disciplinary record of any NASD-registered broker or brokerage firm by calling NASD's BrokerCheck. NASD makes available BrokerCheck at no charge to the public. In 2002, members of the public used this service to conduct more than 2.5 million searches for existing brokers or firms and requested almost 200,000 reports in cases where disclosable information existed on a broker or firm. Investors can link directly to the program by going online to www.nasdbrokercheck.com. Investors can also continue to access this service by calling 1-800-289-9999.
NASD is the leading private-sector provider of financial regulatory services, dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. NASD touches virtually every aspect of the securities business—from registering and educating all industry participants, to examining securities firms, enforcing both NASD rules and the federal securities laws, and administering the largest dispute resolution forum for investors and member firms. For more information, please visit our Web Site at www.nasd.com.