Head of Brokerage Accused of Fraud

An attorney who allegedly reaped $175 million conducting illicit mutual fund trades through a little-known Las Vegas brokerage he controlled was charged with fraud Tuesday by securities regulators.

Daniel Calugar, 49, who lives in Las Vegas and Los Angeles, engaged in “market timing” and after-the-bell trades in funds managed by Alliance Capital and MFS Funds, the Securities and Exchange Commission said in its civil suit. The two firms are among the nation’s 25 biggest mutual fund companies.

A federal judge in Nevada froze the assets of Calugar and his recently shuttered firm, Security Brokerage Inc., last week after the defendant allegedly tried to transfer $50 million from his account at MFS.

“Calugar’s market timing and late trading were phenomenally profitable to him and came at the expense of long-term mutual fund shareholders,” said Randall R. Lee, head of the SEC’s Los Angeles regional office. By getting a judge to freeze Calugar’s assets, the agency has tried “to preserve funds to be returned to the victims of his illegal schemes.”

The SEC is seeking fines and the return of any ill-gotten gains.

Late trading is illegal and involves the buying and selling of mutual fund shares after the stock market has closed, but at that day’s prices. Market timing involves rapid trading in and out of funds to take advantage of pricing discrepancies; it isn’t necessarily illegal but is discouraged by most fund firms.

Regulators say both practices harm other investors by driving up mutual funds’ operating expenses, which are paid for by all shareholders.

MFS spokesman John Reilly said the Boston-based firm had been cooperating with the SEC. “At no time was any MFS employee aware that Security Brokerage was engaged in late trading of MFS Funds,” he added. Reilly declined to comment on whether the firm was aware of market timing by Calugar.

A lawyer for Calugar did not return calls seeking comment.

Calls to Alliance Capital in New York were not returned.

The case, involving trades Calugar allegedly made on his own behalf from at least 2001 to 2003, in part highlights conflict-of-interest questions raised by the market timing and late-trading scandal that erupted Sept. 3 in the mutual fund industry.

Alliance Capital recently settled trading-abuse allegations involving Calugar and others with the SEC for $600 million in fines and fee reductions. The company had an “extensive quid pro quo” agreement with Security Brokerage, the SEC alleged.

Starting in April 2001, Calugar agreed to keep money invested in Alliance’s hedge funds in exchange for the chance to engage in market timing in mutual funds operated by Alliance -- including AllianceBernstein Technology and AllianceBernstein Growth -- even though the firm discouraged the practice.

Alliance knew the scheme was hurting regular investors in its mutual funds, the SEC said last week in announcing its settlement with that firm. The portfolio manager of the technology fund, for example, complained in July that market timers had reduced the fund’s returns by 1.4 percentage points in the first half of the year, the SEC said.

But luring money to its hedge funds from clients such as Calugar was profitable for Alliance.

In an e-mail to colleagues earlier this year, a senior Alliance executive said Calugar was “almost single-handedly supporting” several of the firm’s hedge funds with his total investment of about $60 million.

Analysts said the Calugar case and similar allegations involving other traders could spur the SEC or Congress to address the issue of whether mutual fund companies should be allowed to also manage hedge funds, which are loosely regulated vehicles aimed at well-heeled investors.

“That $175 million is a large number, and it’s going to get people’s attention,” said Don Cassidy, senior research analyst at Lipper Inc. in Denver. “We may be seeing palpable justification for the SEC to write new rules or for Congress to write legislation about it.”

Because hedge funds tend to generate relatively high fees, analysts say, firms may be tempted to favor investors in those products, even if market-timing guidelines are tightened.

“It’s very hard to try to draw lines -- other than total separation -- and hope that people will not find a way around them,” Cassidy said.

MFS rejected a proposal from Calugar for a deal similar to the one he had with Alliance, but he continued to engage in timing of the MFS Funds, the SEC said.

Calugar was able to make after-the-bell trades in the Alliance and MFS funds for at least two years by falsifying his records, the SEC alleged. He entered the order time for the trades as 3:59 p.m. Eastern time -- 1 minute before the stock market’s regular close -- but submitted them to a central clearinghouse for fund trades as much as two hours later, giving him the opportunity to exploit after-hours news, the agency said.

Most mutual funds are priced once a day, at 4 p.m. Eastern time, and orders submitted later are priced at the next day’s close.