Citations
- 612 F. Supp. 2d 241
Full opinion text
OPINION
SWEET, District Judge.
Defendants Pentagon Capital Management, PLC (“PCM”), Lewis Chester (“Chester,” and with Pentagon, “Defendants”), and relief defendant Pentagon Special Purpose Fund, Ltd. (the “Relief Defendant” or the “Pentagon Fund”) have moved pursuant to Rules 12(b)(6) and 9(b), Fed.R.Civ.P., to dismiss the Amended Complaint of the Securities and Exchange Commission (“Plaintiff’ or the “SEC”). On the conclusions set forth below, the motion is denied.
I. PROCEDURAL HISTORY
On April 3, 2008, the SEC filed its complaint against PCM, Chester and the Pentagon Fund, alleging that PCM and Chester had orchestrated a scheme to defraud mutual funds in the United States and their shareholders through late trading and deceptive market timing, in violation of Section 17(a) of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. § 77q(a), Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, thereunder. In the alternative, the SEC asserts a claim of aiding and abetting violations of Section 10(b) and Rule 10b-5. The third claim asserts an unjust enrichment claim against the Pentagon Fund.
On August 1, 2008, the Defendants and Relief Defendant moved to dismiss the complaint. On September 9, 2008, the SEC filed an amended complaint (the “FAC”), asserting the same claims for relief on the basis of additional factual allegations.
Defendants’ motion to dismiss the FAC, filed October 8, 2008, was heard and marked fully briefed on December 3, 2008.
II. PLAINTIFF’S ALLEGATIONS
The following allegations, taken from the FAC, are accepted as true for the purpose of resolving the motion to dismiss.
The Defendants
PCM is an investment adviser and investment manager based in London, England. PCM has provided investment advisory services to the Pentagon Fund and its various feeder funds since at least 1999.
Chester is a resident of London, England. Chester joined PCM in 1998 and has served as PCM’s Chief Executive Officer since 1999. During the relevant period, Chester served as one of the two portfolio managers for the Pentagon Fund, and directed PCM’s market timing and late trading strategies. Chester is a graduate of the University of Oxford in England and the Harvard Business School. He is also a qualified Solicitor of the Supreme Court of England and Wales.
Relief Defendant
The Pentagon Fund is an international business company incorporated by the British Virgin Islands. The Pentagon Fund served as the master fund in a master-feeder fund structure.
Late Trading
The price of a U.S. mutual fund’s shares is based on the value of the securities and other assets held by the mutual fund minus its liabilities. Each fund is required by the SEC’s regulations to calculate the net asset value of the fund’s holdings, or “NAV,” each trading day. Typically, the U.S. mutual funds in which the Pentagon Fund traded calculated the prices of their shares as of the close of the New York Stock Exchange (“NYSE”), normally at 4:00 p.m. ET.
Rule 22c-l(a), 17 C.F.R. § 270.22c-l(a), adopted pursuant to Section 22(c) of the Investment Company Act of 1940 (“Investment Company Act”), 15 U.S.C. § 80a-22(c), requires registered investment companies issuing redeemable securities, principal underwriters and dealers, and any person designated in the fund’s prospectus as authorized to consummate transactions in securities issued by the fund, to sell and redeem fund shares at a price based on the next computed NAV. U.S. mutual funds investing in equity securities virtually always determine the daily price of their shares as of 4:00 p.m. ET or the close of the NYSE, whichever is earlier. U.S. mutual funds’ prospectuses typically state that orders received before 4:00 p.m. ET are executed at the price determined as of 4:00 p.m. ET that day, and that orders received after 4:00 p.m. ET are executed at the price determined as of 4:00 p.m. ET the next trading day.
“Late trading” refers to the practice of placing orders to buy, redeem, or exchange U.S. mutual fund shares after the time as of which the funds calculate their NAV, but receiving the price based on the prior day’s NAV. The late trader, by obtaining the previously determined NAV, is able to profit from market events that occur after 4:00 p.m. ET and not reflected in that day’s price. Late trading harms innocent shareholders in mutual funds by diluting the value of their shares.
In order for U.S. broker-dealers to serve as dealers for a particular mutual fund company’s funds, and thereby sell the company’s mutual fund shares to their customers, U.S. broker-dealers and/or their respective clearing brokers typically enter into dealer agreements with the distributors, or principal underwriters, of various U.S. mutual funds. These agreements typically require the broker-dealers to sell the U.S. mutual funds in accordance with the federal securities laws and the terms of the mutual funds’ prospectuses.
The mutual fund prospectuses typically state that the publicly available price, or NAV, for the funds’ shares is calculated as of 4:00 p.m. ET, or as of the close of the NYSE. The prospectuses typically require U.S. broker-dealers to receive orders to purchase, redeem, or exchange shares of a fund no later than 4:00 p.m. ET for such orders to be executed at that day’s NAVI
Certain U.S. broker-dealers, known as “introducing brokers,” enter into clearing agreements with other U.S. broker-dealers. For example, broker dealer “TW & Co.,” a broker-dealer formerly registered with the SEC, cleared its mutual fund and other securities transactions through Banc of America Securities, LLC (“BofA”). The clearing agreement between BofA and TW & Co. stated that the “[a]greement, and all transactions and activities [thereunder, were] subject to the federal and state securities laws,” including the Securities Act, the Exchange Act, and the Investment Company Act. The clearing agreement provided that TW & Co., and not BofA, was “solely and exclusively responsible for,” among other things, ensuring that all TW & CO.’s customers’ trades “comply in all respects with” the securities laws. BofA’s trading instructions were contained in a manual given to the introducing broker-dealers, including TW & Co. These instructions specified that mutual fund orders should be received by 4:00 p.m. ET in order to receive the current day’s NAV.
U.S. broker-dealers typically route mutual fund orders via the Fund/SERV platform, an automated system for processing purchase, redemption and exchange orders of U.S. mutual fund shares. Fund/SERV typically acts as a communication hub between the U.S. broker-dealers and the primary transfer agent of the U.S. mutual funds.
During the relevant time period, U.S. broker-dealers often received customer orders prior to 4:00 p.m. ET but did not submit the trades via the Fund/SERV platform until after 4:00 p.m. ET. These trades were eligible for the current day’s NAV so long as the U.S. broker-dealer received the final order prior to 4:00 p.m. ET.
The U.S. mutual funds were not able to determine from the Fund/SERV platform the time at which U.S. broker-dealers received orders from their customers. The U.S. mutual funds thus relied on the U.S. broker-dealers to comply with the federal securities laws, the funds’ prospectuses and dealer agreements, and, if applicable, the U.S. broker-dealers’ clearing agreements.
PCM and Chester took advantage of this system by searching for and locating registered representatives (“RRs”) at U.S. broker-dealers who were willing to accept Pentagon Fund orders after 4:00 p.m. ET and submit them as if they had been received before 4:00 p.m. ET, and in so doing deceived U.S. mutual funds who believed that the trades had been received prior to 4:00 p.m. ET.
In the late 1990s, PCM and Chester caused the Pentagon Fund to open non-discretionary brokerage accounts at a number of U.S. broker-dealers, including those referred to in the FAC as TW & Co., CIBC, PRU, CONC, PW, BBH, CIC, SSB, and MS. Because the Pentagon Fund’s brokerage accounts were “non-discretionary,” only PCM — not the RRs at the U.S. broker-dealers — had discretion to submit trades on behalf of the fund.
PCM utilized proprietary trading models to trade U.S. mutual funds in certain sectors, initially concentrating on funds investing in international equities.
After PCM began trading U.S. mutual funds, Chester knew that PCM had to submit U.S. mutual fund trades for Pentagon Fund by 4:00 p.m. ET for Pentagon Fund to receive that day’s NAV. For example, after Pentagon Fund brokerage accounts were opened at PW with RRs James A. Wilson Jr. and, Scott Christian, Chester sent an April 13, 2000 email to Wilson with an attached spreadsheet that indicated that PCM had to submit trades prior to 4:00 p.m. ET.
Chester, however, sought the ability to submit U.S. mutual fund trades after 4:00 p.m. ET, but still receive the current day’s NAY. On May 5, 2000, Chester had a discussion with Wilson and Christian about the latest time PCM could submit trades. Chester memorialized the discussion in a memorandum that indicated that they had “discussed the latest time for trading on the [broker-dealer PW] accounts. [Wilson] stated that currently we would be able to trade up to 4pm New York time (9pm UK time). Within a period of weeks, he should be able to accept trades up to 4.15pm New York time.”
Christian then sent Chester an email on May 26, 2000, that indicated that PCM had to enter its trades by 4:00 p.m. ET because U.S. mutual funds were priced as of that time:
Regarding after hours trading, I have spoken to a few sources and so far they have come back to me with the idea that mutual funds trading will still halt at 4 pm. If portfolio managers are still purchasing assets in the market after 4 then these will be reflected in the following day’s price. Therefore the pricing of the mutual funds will not be affected by the after hours market since the pricing will be based on activity prior to 4 pm that day. Anything after 4 will reflect in the price for the following day’s close.
Wilson and Christian were not able to arrange for late trading through PW. Chester and other PCM personnel also spoke with RRs from other U.S. broker-dealers, including CIC and PRU, in an attempt to late trade through their respective U.S. broker-dealers. The Defendants were advised that they were required to submit the current day’s U.S. mutual fund trades prior to 4:00 p.m. ET.
In late 2000, Wilson and Christian moved to broker-dealer TW & Co. and advised Chester that PCM could submit late trades in U.S. mutual funds. PCM promptly caused the Pentagon Fund to open non-discretionary brokerage accounts at TW & Co.
On April 5, 2001, Chester sent an email to Wilson and Christian that contained the following:
AFTER HOURS TRADING INSTRUCTIONS
I have spoken to my R & D people regarding a procedure for going IN, OUT or canceling an IN or OUT on any given night, as per our telephone conversation last night.
Lets [sic] us know what the current cutoff time is (5:30 p.m. N.Y. time?) and when you’ll have the 6:30p.m. facility — I think you told me it will be available from Monday? ? ?
Chester’s April 5, 2001 email also included a template for taking advantage of after-hours information:
The procedure we are thinking of putting in place is as follows (subject to speaking this through to Trevor [another PCM employee]):
— Trevor’s team will give you a single figure on the S & P future (e.g. 1320), at or around the close
— If the future exceeds (for an IN) or falls below (for an OUT) — see examples below — after hours, then try to get hold of one of us by-telephone
— If you can’t get hold of us, then do the corresponding trade
— Send Trevor an e-mail letting him know what you’ve done
My R & D team is building an application for Trevor’s team to spew out the requisite S & P future figure each night for you. We should be able to be up and running on this within a day or two.
On April 9, 2001, Chester sent an email to Wilson and Christian asking whether they were ready to start late trading: “Are you know [sic] able to do trades up to 6:30 pm N.Y. time?” Wilson responded in an email to Chester on April 10, 2001, as follows:
[Christian] and i feel that if you are going to use our late trading — -“it” (you said) adds a certain percentage of value — we would then like some kind of system or proposal on how we can make money on this ... [because] if we are going to trade later then we need parameters so we can establish guidelines — im [sic] not staying here every-night [sic] without cause — i feel things are tight allover [sic] and there are only so many places to do this .. so lets [sic] be partners or such .. cheers
Chester responded in an April 11, 2001 email to Wilson and Christian that contained the following:
Re: Late Trading
1. We are partners. I have always gone out of my way to support you. When you went to [PW], we gave you assets asap, and then when you went to [TWS & Co.], you [sic] gave you assets asap....
2. Your facility for late trading is not the only one we have. In all the other cases, we pay 1% p.a....
5. You currently earn 2% p.a. This is double what Pentagon earns as a management fee. (Our performance fee reflects the strength or otherwise of our modeling decisions, and hence is as variable as our decisions.) We work all the hours of the day to ensure we do our best for the client. To ask you or Scott, or someone else at [TWS & Co.] to cover until 6:30pm each night, really is no big deal. And you know it. Remember, the more money we make, the more fees you earn — 2% of a larger figure. Hence, it’s in everyone’s interests to ensure we get the later trading times.
I really EXPECT you guys to go out of your way to make sure I get late trading — you’re earning double what everyone else takes home on this business— although it’s unlikely that we’ll need 6:30pm trading every night.
I really want to be your biggest client. I want to be the first to try your new products. And I want you to have the best facilities/trading. And that’s why I am happy to pay you double what I pay any one else.
On April 11, 2001, Wilson sent an email to Chester including the following:
We are the only place to trade late past 530 — in the [U.S.] with any brokers. — fact.; ~)
Thus you have to pay more ...
On May 9, 2001, a PCM employee sent an email to Christian at TW & Co. attaching a document entitled “Notes on Trading Domestic Technology Funds” that provided more detailed instructions on how PCM wanted TW & Co. to execute late trades on behalf of Pentagon Fund. Specifically, the document indicated that PCM’s trading model “outputs a couple of lines of text at about 16:10 (New York time).” The document then provided the following trading instructions for trading U.S. mutual funds holding technology company securities:
[T]he procedure for trading these funds is as follows (all times are New York):
1. At or around 16:10, the dealing team at Pentagon phone [TW & Co.] to tell them the output of the model.
2. At 17:30, if the condition on the futures is met and the futures are outside the “warning” band, [TW & Co.] execute the trades — no need to phone Pentagon.
3. At 17:30, if the condition on the futures is not met and the futures are outside the “warning” band, no trades executed — [TW & Co.] can go home!
4. At 17:30, the futures are in the warning band, [TW & Co.] phones Lewis [Chester) at Pentagon, or the list of phone numbers that Trevor will supply for further instructions, which might include waiting for another hour.
Having secured the ability to late trade, PCM also took steps to increase Pentagon Fund’s assets in brokerage accounts at TW & Co. through financing from CIBC.
On May 1, 2001, Chester sent an email to Wilson and Christian outlining his plan to submit late trades up to 6:30 p.m. ET:
We’re sending you some leverage money — hopefully [CIBC] and your lawyer will get off their backside and complete the bloody leverage documentation! — for domestic funds. Trevor will call you later to discuss.
Hopefully this should stop your endless, pathetic, pittiful [sic] moaning that I’ve been subjected to for years.
It does mean you might have to work a little harder ... pour souls, working past cookie and milk time ... for once in your lives, you can work like real men and do a proper day’s work. (You really are a bunch of women of the first order). Trevor will run through the procedures of how the trading is going to work. In essence, most of it will be done by you within certain parameters that we will give you each day. In the majority of cases, your decision point will be 5:30 pm N.Y. time. In a few cases, your decision point will be 6:30 pm — I know, slave labor ... whatever will you do working that late!
When there are close decision, you’ll have a list of home / cell numbers for me, Trevor, Jafar [PCM’s Chief Operating Officer] and Anthony [another PCM employee] (priority in that order) ... and we’ll make the call. If you can’t get through to us, then on a close decision, you’ll need to act like men and make the call. (Not too difficult really, as it’s not your money!)
From approximately May 2001 to September 2003, PCM and Chester routinely submitted trading decisions after 4:00 p.m. ET for Pentagon Fund’s brokerage accounts at TW & Co., and TW & Co. falsely represented that PCM’s orders had been received prior to 4:00 p.m. ET, thereby ensuring that the Pentagon Fund would receive that day’s NAVs for the trades. During this period, PCM placed thousands of trades through TW & Co., including hundreds of trades after April 3, 2003, many of which were late trades.
Typically, PCM sent TW & Co. tentative trading instructions early each afternoon. TW & Co. RRs Wilson and Christian would then time-stamp the order tickets prior to 4:00 p.m. ET. After 4:00 p.m. ET, PCM’s model generated trading instructions, and PCM personnel conveyed the day’s final trading instructions to TW & Co. between 4:00 p.m. ET and 5:30 p.m. ET or even later. TW & Co. would then relay the Pentagon Fund’s orders through BofA, TW & Co.’s clearing broker, to U.S. mutual funds via Fund/SERV. The U.S. mutual funds, deceived into believing that the orders had been placed prior to 4:00 p.m., would assign that day’s NAV to the orders.
In addition, if PCM learned of market moving developments after it had provided the day’s trading decisions for Pentagon Fund accounts, PCM generally amended its trading instructions for the day.
PCM sought and received from TW & Co. the current day’s NAV prior to PCM transmitting final trading decisions to TW & Co. for the day — thereby gaining an extra measure of profit on the trades.
PCM continued to late trade U.S. mutual funds in the Pentagon Fund’s accounts at TW & Co. until the public announcement in early September 2003 that the New York Attorney General filed settled fraud charges against hedge fund Canary Capital LLC for engaging in late trading.
Pentagon also engaged in late trading through broker-dealer CONC. In early 2003, a RR from CONC met with Chester in New York and solicited Chester to open accounts at CONC. During the meeting, Chester requested the ability to enter current day orders on behalf of the Pentagon Fund after 4:00 p.m. ET. The RR agreed to allow PCM to place current day trades after 4:00 p.m. ET.
Subsequently, a PCM employee spoke with the RR about the need to make trading decisions after 4:00 p.m. ET. The PCM employee confirmed the discussion in an email to the RR at CONC:
I understand that on a daily basis I can call in the trade at 4.20 pm but need to call at 4.10 pm for indication. Though on an obvious evening I’d give the decision before then. However, on an evening when we know there will be after hours news I can call in my trade at 5.15pm. Its [sic] on these nights that I’d be likely to move fully my domestic positions to take advantage of the late trading privilege you guys are offering.
PCM placed trades after 4:00 p.m. ET on four occasions for the Pentagon Fund at CONC between March 2003 and August 2003 with the expectation that CONC RRs would falsely represent that these orders had been received prior to 4:00 p.m. ET, thereby ensuring that the Pentagon Fund would receive that day’s NAVs for the trades.
In an April 10, 2003 email to an RR at CONC, a PCM employee noted that companies would soon be reporting earnings after the market close:
Starting from today and next week but excluding tomorrow I’ll need someone to stay late at [CONC] as we’ll be in reporting season. We’ve got Juniper [Networks] & Network Associates as the “big” ones tonight.
Chester had discussions with TW & Co. personnel concerning the legality of late trading. For example, during the fall of 2001, Chester called Wilson and played a voicemail message that a RR from another U.S. broker-dealer that PCM used, CIBC, had left for Chester. On the voicemail message, the CIBC RR told Chester to stop pushing CIBC RRs to accept late trades, and that late trading was illegal.
On June 7, 2002, Christian sent an email to Chester with an article concerning the market timing of U.S. mutual funds with international holdings. The article noted that such funds calculated NAVs at 4:00 p.m.
On or about August 5, 2003, Chester received a paper entitled “Mutual Fund Market Timing Strategies,” which included the following:
In the United States, all mutual funds are traded electronically through the NSCC (National Securities Clearing Corporation) or through FundServ and are executed at the end of the market at 4:00 pm (Eastern Standard Daylight time).
Within the FundServ or NASD trading operation, the trade execution of mutual funds is performed at the transfer agent for each mutual fund group at the close of the U.S. markets at 4:00 p.m. at the same-day NAV for settlement T + l (trade date plus one).
Chester’s notations on the paper indicated that it was “very informative about U.S. mutual fund market timing.”
Market Timing
“Market timing” includes: (i) frequent buying and selling of shares of the same mutual fund or (ii) buying and selling mutual fund shares in order to exploit inefficiencies in mutual fund pricing. Market timing can harm other mutual fund shareholders by diluting the value of their shares. Market timing, while not illegal per se, can disrupt the management of a mutual fund’s investment portfolio and cause the targeted mutual fund to incur considerable extra costs associated with excessive trading and, as a result, cause damage to other shareholders in the fund.
Many mutual fund prospectuses stated that the funds prohibited or restricted market timing and reserved the right to reject purchases and exchanges deemed excessive, and many U.S. mutual funds attempted to track market timers in order to stop market timing trading within their funds.
When mutual funds identified a market timing trade, they frequently imposed restrictions on the shareholder and/or account that had traded. The mutual funds then notified the relevant U.S. broker-dealer that such trade had been rejected, and the relevant brokerage account restricted. The mutual funds would then permit the shareholder to exchange into the money market fund and/or redeem its shares, but the mutual funds would not permit the shareholder to purchase shares of another equity mutual fund within the fund company.
When a U.S. mutual fund rejected a market timing trade in a particular brokerage account, the fund typically intended that the restrictions that were imposed applied to all accounts owned or managed by the same shareholder. The mutual funds were often unable to enforce their restrictions, however, because market timers often continued trading within the same mutual fund companies using deceptive tactics such as continuing to trade through different brokerage accounts that the mutual fund had not yet identified or restricted.
The FAC alleges that because Chester and PCM knew that U.S. mutual funds disliked and prohibited and/or restricted market timing, they needed to hide the Pentagon Fund’s market timing trading from U.S. market funds. They split Pentagon Fund trades among multiple brokerage accounts at multiple U.S. broker-dealers in order to conceal the Pentagon Fund’s trading from the mutual funds. After mutual funds blocked the Pentagon Fund’s trades, PCM and Chester caused the Pentagon Fund to open additional brokerage accounts at various U.S. broker-dealers to deceive U.S. mutual fund companies into continuing to allow the Pentagon Fund to trade following rejections. RRs at various U.S. broker-dealers, with the knowledge and consent of PCM and Chester, furthered the scheme by employing additional deceptive tactics such as the use of multiple RR numbers in order to conceal the Pentagon Fund’s identity from the mutual funds.
PCM and Chester caused the Pentagon Fund to open multiple accounts at TW & Co. In total, PCM and Chester caused the Pentagon Fund to open 68 brokerage accounts at TW & Co. Wilson and Christian established 17 different RR numbers to assist their market timing clients, including PCM and the Pentagon Fund. PCM and Chester used the multiple accounts and worked with Christian and Wilson to use the multiple RR numbers- to evade mutual funds’ efforts to block Pentagon Fund’s market timing trading.
For example, on September 21, 2001, a U.S. mutual fund company (“Mutual Fund Co. B”) filed a prospectus with the SEC that noted that its funds had the right to limit exchanges to four times per year.
On November 28, 2001, Christian sent an email to PCM to advise it that Mutual Fund Co. B had rejected trades PCM had submitted in seven Pentagon Fund accounts. PCM continued to market time Mutual Fund Co. B’s mutual funds for Pentagon Fund accounts. The next day, on November 29, 2001, Pentagon. Fund purchased shares in Mutual Fund Co. B’s mutual funds in a different account, and sold the, position the following day. In total, , after November 28, 2001, PCM placed 93 purchases and exchanges of Mutual Fund Co. B’s mutual funds through 31 different Pentagon Fund accounts at TW & Co.
On April 24, 2001, AIM filed a prospectus with the SEC containing the following language:
You are limited to a maximum of 10 exchanges per calendar year, because excessive short-term trading or market-timing activity can hurt fund performance. If you exceed that limit, or if an AIM Fund or' the distributor determines, in its sole discretion, that your short-term trading is excessive or that you are engaging in market-timing activity, it may reject any additional exchange orders. An exchange is the movement out of (redemption) one AIM Fund and into (purchase) another AIM Fund.
On February 22, 2002, AIM sent a letter to BofA, TW & Co.’s clearing firm, which BofA forwarded to TW & Co., concerning several accounts at the broker-dealer including Pentagon Fund account no. 797-70021. The letter indicated that AIM had “closely monitored the effects of market timing and short-term trading within our family of funds” and had “determined that these activities, if not properly addressed, may hinder our ability to achieve the desirable long-term investment results for our shareholders.” Further, AIM’S letter indicated that, pursuant to the prospectus, shareholders were restricted to ten exchanges per year, and that AIM could reject purchase orders if it determined that short term trading was excessive. Finally, the letter advised that the referenced accounts had already exchanged eight times, and that following a tenth exchange “a stop code will be placed on the accounts preventing further exchanges and purchases in 2002.” TW & Co. informed PCM of this restriction.
PCM and TW & Co. subsequently-caused the Pentagon Fund to open new brokerage accounts and continued to market time AIM’S mutual funds. Specifically, on approximately March 4, 2002,. PCM directed TW & Co. to open three new brokerage accounts for the Pentagon Fund. Then, beginning March 6, 2002, PCM continued market timing AIM’S mutual funds through these new Pentagon Fund brokerage accounts.
On June 29, 2001, Putnam, a U.S. mutual fund company, filed a prospectus with the SEC containing the following language:
The exchange privilege is not intended as a vehicle for short-term trading. Excessive exchange activity may interfere with portfolio management and have an adverse effect on all shareholders. In order to limit excessive exchange activity and otherwise to promote the best interests of the fund, the fund reserves the right to revise or terminate the exchange privilege, limit the amount or number of exchanges or reject any exchange. The fund into which you would like to exchange may also reject your exchange. These actions may apply to all shareholders or only to those shareholders whose exchanges Putnam Management determines are likely to have a negative effect on the fund or other Putnam funds.
On March 1, 2002, Putnam sent a letter to TW & Co. concerning several accounts, including Pentagon Fund’s account no. 797-70090. Putnam’s letter indicated that it had “identified accounts ... that have excessive exchanges,” and that it was “terminating your ability as broker of record to open new accounts at Putnam' under your representative identification.” Further, Putnam’s letter stated that it would “not allow accounts for which you are broker of record and which are networked or trade within omnibus accounts to exchange into any other fund,” other than a money market fund, and that it was taking this action because it had “found that excessive exchange activity of a small number of individuals was causing volatility in the funds’ cash position” and that “this can have a detrimental effect on fund performance.” TW & Co. informed PCM about this block.
PCM and Chester subsequently caused the Pentagon Fund to open new brokerage accounts and continued to market time Putnam mutual fund shares. On March 8, 2002, PCM caused the Pentagon Fund to open eight new brokerage accounts, and TW & Co. assigned new RR numbers to the new accounts not previously used in connection with Pentagon Fund accounts. Then, beginning March 14, 2002, PCM continued market timing Putnam mutual fund shares through the new Pentagon Fund brokerage accounts.
On October 30, 2002, ACM/Alliance, a U.S. mutual fund company, filed a prospectus with the SEC stating: “[a] Fund may refuse any order to purchase shares. In particular, the Funds reserve the right to restrict purchases of shares (including through exchanges) when they appear to evidence a pattern of frequent purchases and sales made in response to short-term considerations.”
From January 15, 2003, through February 13, 2003, AIM blocked Pentagon Fund accounts at broker-dealer PRU. In addition, from January 15, 2003, through February 11, 2003, ACM/Alliance blocked Pentagon Fund accounts at PRU.
On January 16, 2003, a PRU RR, Justin Ficken, sent an email to a PCM employee, stating:
I will need to redeem the following because they were stopped:
AIM in Performance 12 and Management 12
[ACM/Alliance] Offshore in Performance 12, Performance 5, Performance 4, Management 7, Management 12, Management 8. (They all did five exchanges in about two months. That would be about 30 in a year — a bit much, no?)
On or about February 27, 2003, PCM caused the Pentagon Fund to open four new brokerage accounts at PRU. PCM subsequently utilized these additional accounts to continue trading AIM mutual funds. In addition, PCM continued to use existing Pentagon Fund accounts at PRU that had not been blocked to trade AIM’S mutual funds. In total, PCM used at least 26 accounts at PRU with 7 different RR numbers associated with them to market time U.S. mutual funds of at least 50 mutual fund companies.
On several occasions, after U.S. mutual funds blocked the Pentagon Fund’s accounts at one U.S. broker-dealer because of market timing, PCM and the Pentagon Fund continued to trade within the same mutual fund companies through accounts at a different U.S. broker-dealer.
For example, on November 6, 2001, Putnam sent a letter to TW & Co. that referenced a Pentagon Fund brokerage account. The letter contained the following:
Putnam is terminating your ability as broker of record to open new accounts at Putnam under your representative-identification.
Putnam will not allow accounts for which [TW & Co. is] broker of record and which are networked or trade within omnibus accounts to exchange into any other fund, other than the Putnam Money Market Fund. Once invested in the Putnam Money Market Fund, those accounts will not be allowed to exchange into any other Putnam fund.
To circumvent this restriction, PCM entered trades through different U.S. broker-dealers. Specifically, after November 6, 2001, Pentagon Fund brokerage accounts made the following numbers of trades in Putnam mutual funds: 184 purchases and exchanges through CIBC, 34 through CONC, 141 through PW.
After ACM/Alliance blocked six Pentagon Fund brokerage accounts at PRU on January 15, 2003, PCM continued to place trades in ACM/Alliance mutual funds through Pentagon Fund brokerage accounts at TW & Co. In total, PCM executed 22 additional purchases and exchanges of ACM/Alliance mutual funds through Pentagon Fund brokerage accounts at TW & Co. PCM also executed an additional 25 purchases and exchanges of ACM/Alliance mutual funds through broker-dealer CONC. .
The FAC alleges that PCM was aware that the Pentagon Fund needed to keep trades “under the radar” of certain U.S. mutual funds. In a May 3, 2002 email, a PCM employee wrote to PRU RR Ficken:
On [ACM/Alliance] are you getting a lot of kickouts? I’ve just heard on the street [ACM/Alliance] are now monitoring any trades over $200k. May be we need to keep them below $200k for a longer stay.
PCM split up trades among Pentagon Fund accounts to deceive the U.S. mutual funds about the extent of the Pentagon Fund’s market timing. For example, on July 25, 2001, PCM utilized