Legg to pay SEC $1 million fine

Agency finds late trading, spotty records

September 22, 2005|By Laura Smitherman | Laura Smitherman,Sun reporter

Legg Mason Inc. agreed yesterday to pay a $1 million fine to settle allegations from regulators that the Baltimore firm failed to block thousands of illegal, after-hours trades in mutual funds.

The Securities and Exchange Commission found that Legg Mason's processing system allowed thousands of trades posted after the 4 p.m. close of regular trading to get the pre-close price. The federal agency didn't uncover evidence that investors systematically took advantage of the glitch. Such a scheme could have diluted the holdings of all shareholders in a mutual fund.

"The system was so flawed that they had no real way of knowing what was happening or when the actual orders came in," said David S. Horowitz, assistant district administrator of the SEC's Philadelphia office.

The case arose as part of an industrywide probe of mutual funds undertaken by the SEC and New York Attorney General Eliot Spitzer. While Legg Mason has been considered a relatively bit player in the scandals, the firm has not gone unscathed. Regulators fined it $2.3 million last year for not giving volume discounts owed customers, and another investigation into undisclosed allegations continues.

Legg Mason said it fixed the processing system used by its brokers soon after the problem was discovered in 2003.

As part of the settlement, Legg Mason agreed to retain an independent consultant to ensure compliance with trading regulations.

Legg Mason announced in June that it would swap its broker division for the money management business of Citigroup Inc. in a $3.7 billion deal that's expected to close this year. Citigroup spokeswoman Shannon Bell declined to comment.

Legg Mason spokesman Jeffrey Bukowski said the brokerage division "cooperated fully with the SEC" and, "We are pleased to report that we consider the matter to be resolved."

According to the SEC, more than 18,000 late trades were processed at that day's price - rather than the next day's price - over 13 months in 2002 and 2003 when the firm posted about 150,000 trades a month.

The firm didn't keep adequate records, also in violation of other regulations, so the SEC wasn't able to take a detailed look at trading in previous years, Horowitz said.

Some mutual firms let favored investors capitalize from late trading. While a mutual fund is priced once a day based on the value of the assets it holds, stock prices fluctuate in real time. So if a fund holds a stock that announced good news after markets closed at 4 p.m., for example, then it's a good bet the stock as well as the fund's price would rise the next day. Investors making large moves in and out of funds with an unfair advantage would dilute the profits of the fund's ordinary investors.

Legg Mason bought an off-the-shelf processing system in 1997 and didn't upgrade the program, which processed orders for funds not managed by the firm, when an option to define a cut-off time became available the next year.

A version of the system used for Legg Mason's own funds processed late trades in error as long as brokers opened an order-entry computer screen before 4 p.m.

"The procedural gaps and systematic breakdowns caused confusion," the SEC said.

Brokers and operations personnel "generally believed they were complying with, or otherwise misunderstood, the firm's internal policy," the SEC said.


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