State regulators have begun their own investigation of Strong

Agency could suspend the licenses of advisers

By PAUL GORES pgores@journalsentinel.com, Journal Sentinel

Sunday, November 9, 2003

While New York Attorney General Eliot Spitzer and the Securities and Exchange Commission grab headlines as they probe the books of Strong Capital Management Inc., state securities regulators quietly are taking their own look at the Menomonee Falls mutual fund firm.

The Wisconsin Department of Financial Institutions, made aware of allegations of improper trading at Strong through Spitzer’s high- profile investigation of abuses in the $7 trillion mutual fund industry, asked Strong for a stack of records in late September.

“We did request information from Strong in our investigation,” said Lorrie Keating Heinemann, secretary of the state regulatory agency. “We did receive a very large amount of forms from them. So our investigation is moving forward based on our requests and the receipt back of those documents.”

Keating Heinemann said because the investigation is ongoing, she could not comment on details.

But she noted that the SEC — which oversees the mutual fund industry, while states monitor smaller investment operations and individual advisers — still is the lead agency in the Strong case.

She also said her department has been in contact with Attorney General Peg Lautenschlager about the investigation. But Lautenschlager said her office is waiting to see if DFI, which is the primary examiner of banks and securities dealers in Wisconsin, finds anything that might warrant civil charges or criminal violations.

One disciplinary action not uncommon for the Department of Financial Institutions is to suspend or revoke individual investment adviser licenses.

That may seem like a small penalty compared with the profit givebacks and concessions Spitzer is seeking. But to have the state pull the licenses of some advisers at a local firm such as Strong, would, at the very least, be another stain on the reputation of a company in an industry where reputation is of great importance.

Spitzer, the SEC and the state are investigating trading by employees of Strong, including the company’s chairman and founder, Richard S. Strong. Spitzer has alleged that Strong made about $600,000 for himself, family and friends by improperly conducting “market timing” trades in funds managed by his company.

Market timing, in which trades are made quickly to take advantage of market-moving news, can dilute gains for other investors in those mutual funds. Most mutual fund shareholder are long-term investors, and many mutual fund companies discourage market timing by shareholders, though it is not illegal.

Richard Strong has said he doesn’t believe the transactions were disruptive to the funds. Nonetheless, he has vowed to personally reimburse the funds for any financial losses that may have taken place because of the trades. The funds’ board of directors — from which Strong resigned as chairman last Sunday — has hired independent consultants to conduct its own investigation and recommend any policy and procedures changes that may be needed.

Earlier, Spitzer filed a complaint that implicated Strong Capital Management in allowing the New Jersey hedge fund Canary Capital Partners to market-time by trading five Strong funds more actively than other shareholders, and in providing to Canary lists of those funds’ holdings more often than other shareholders received them.

Spitzer contends there are “red flags” in mutual fund reports that indicate market timing is taking place, and regulators and boards of directors should be able to see them.

So why did it take an attorney general in New York to notice alleged improper trading in a company based in Wisconsin?

If the blame lies with any regulator, it’s the SEC — not state securities examiners or the state attorney general’s office, said Jeff Squires, a principal with Vista360, a Milwaukee consulting firm that provides regulatory compliance and operations services to investment firms.

“If we’re looking at who fell asleep at the wheel, then the first finger has to be pointed at the SEC because Strong was directly under their jurisdiction,” Squires said.

Until the mid-1990s, federal and state regulators covered much of the same ground in their examinations and oversight of mutual funds and investment companies. But in 1997, Squires said, the federal and state governments agreed it made more sense to split the duties.

The SEC kept the authority to regulate mutual funds and the largest investment firms, while states were given jurisdiction over companies with $25 million or less of assets under management.

“States still retain some rights to oversee,” Squires said. “For example, investment adviser representatives have to be licensed with the state, and some states still have some sort of fraud issues. In other words, if they think you are conducting something that’s fraudulent in the state, they can go after you. That’s how Spitzer is going after a lot of these folks in New York.”

Laura Rauman, who also is a principal at Vista360, said that unless state regulators received a complaint or had some reason to suspect wrongdoing at a company the size of Strong, they normally wouldn’t be involved in looking at its books.

“Now in this case, they’re in there, and it’s probably because it’s happening in their own back yard and there are allegations out there,” Rauman said.

But Spitzer, a Democrat who has made a name for himself by catching financial companies in wrongdoing, is the ramrod on the mutual fund reform issue. He is not averse to taking swipes at Strong, which he did last week in front of a House subcommittee, when he called the firm “Exhibit A” in dereliction of duty by mutual fund directors.

“Clearly, his office has an entire unit devoted to this matter and a variety of similar matters,” Lautenschlager said.

After a previous Spitzer-led investigation, Wisconsin last spring received about $7 million from a $1.4 billion reform settlement with many of the top firms on Wall Street. In that investigation, analysts at brokerage houses were alleged to have recommended stocks due to improper influence from their investment banking colleagues.