Dec. 5–A Dallas brokerage, Mutuals.com, was accused by the Securities and Exchange Commission of defrauding investors and mutual funds with illegal after-hours trading and market timing.

The SEC’s suit, filed Thursday in U.S. District Court in Dallas, is the first case of a Texas company implicated in the widening scandal. It asks that Mutuals.com be forced to disgorge $7.9 million it earned illegally from 2001 to this year, as well as other penalties. Mutuals.com continued its practices even as 294 mutual funds barred the firm from trading their shares.

The SEC also seeks an injunction to stop illegal trading practices and has appointed a special monitor to oversee Mutuals.com’s own mutual fund.

The complaint charges that Mutuals.com often masked its activities by changing account numbers or the names of shareholders.

The complaint quotes officials with Pershing LLC, a firm that cleared trades, describing Mutuals.com’s tactics as “not unlike a rock band which knows that they continue to trash hotel rooms on their tours — and as soon as Hyatt throws them out, they’ll move on to Hilton, then Marriott, then somebody else.”

Mutuals.com, organized in 1994, is a broker-dealer firm that traded mutual fund accounts for hedge funds and other institutional investors. The complaint filed Thursday charges that Mutuals.com engaged in illegal activities on behalf of 18 large institutional clients.

The attorney for Mutuals.com, Steve Topetzes of Washington, D.C., said his clients would “vigorously contest” the allegations. He said that Mutuals.com had cooperated with the SEC investigation.

Topetzes said that the trades in question were “nondiscretionary, done at the behest of several large clients.” The lawyer noted that Mutuals.com’s own mutual fund was not implicated in any wrongdoing.

The action is part of the enlarging mutual fund scandal that broke this year in New York. Several other regional trading companies, most notably Strong Financial Corp. of Milwaukee and Invesco Funds Group of Denver, have been caught up in state and federal investigations. Mutuals.com is thought to be the first Texas-based company implicated in the scandal.

The district administrator of the SEC’s Fort Worth office, Hal Degenhardt Jr., said Mutuals.com represented “another unfortunate example of the betrayal of mutual fund shareholders and, in this case, their mutual funds.”

The mutual funds themselves played a role in the investigation.

Degenhardt said that hundreds of funds had barred Mutuals.com from trading their shares.

“But in many cases, Mutuals.com got around that by changing the account numbers for their trades,” Degenhardt said.

The core of the complaint against Mutuals.com centers on after-hours trading, or trades made after 3 p.m. Central Time, when mutual fund shares are valued for the day. An investor with later information that would increase value during the next day’s trading would buy the shares at the fixed price and reap profits the next day after trading restarted.

“A mutual fund share is not like a stock, whose value continues to move after the close of the stock exchanges,” Degenhardt said. “If some people can trade mutual fund shares after hours, they can trade on information that is not available to others. The evil is in the unfairness.”

Also, Degenhardt and other critics have alleged that after-hours trades generate more transaction charges, which must be borne by all investors in the funds. The complaint charges that Mutuals.com received $4.6 million in so-called “wrap fees” for after-hours transactions for 18 primary clients. By contrast, the transaction fees for trading common stocks are borne by the brokerages, not the issuing companies.

In addition to after-hours trading, Mutuals.com is alleged to have engaged in market timing, even after mutual funds asked the company to cease that activity.

Some large traders like to buy blocks of mutual fund shares, hold them for just a day or two, then sell in order to reap short-term profits. Again, such tactics generate transaction fees that the fund must pay to the detriment of smaller shareholders who don’t participate in such activities.

Unlike after-hours trading, market timing isn’t illegal. But many mutual funds discourage the practice because it tends to harm long-term mutual fund shareholders, primarily by driving up the fund’s transaction costs.

The complaint charges that after the 294 mutual funds barred Mutuals.com from trading its shares, Mutuals.com set up two new broker-dealer firms, Connely-Dowd Management and MTT Fundcorp, through which they could continue to make trades undetected.

The complaint also names Richard Sapio, 37, of Dallas, Mutuals.com’s principal owner and chief executive, as well as President Eric McDonald, 35, of DeSoto, and Michele Leftwich, 35, of Dallas, the firm’s chief compliance officer.

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AVZ,