You are on page 1of 11

Background

The situation Bank One faced is indeed a delicate and lethal one for the
company. In hopes of earning high profits, Bank One engaged in illegal and
unethical practice in the mutual fund market. Bank One is not the only
organization engaged in the illegal practice but other financial firms are too.
But in the verge of time, the crime was caught and all of the concerned were
prosecuted.

The new management did whatever it could to save the firm from extinction.
But the poor prediction of the strategic objectives set by the previous
management of Bank One really put Bank One’s future into jeopardy. The
new management on the other hand was quick to adapt the correct and
foreseeable strategic objectives in to place in order to save the organization.
The new management at Bank One not only selected the correct strategies,
but even put into play or applied the management strategies accordingly.

The new management at Bank One took up the strategy to save the brand by
promoting positive image of the company and by supporting all the stake
holder to their level best. They even set up a merger with J.P. Morgan Chase
creating the second largest financial institution in the world. But before the
merger, Jamie Dimon, CEO of Bank One Corporation needs to settle the final
settlement of the charges brought by the Securities and Exchange
Commission (SEC) and New York State Attorney General Eliot Spitzer
against Bank One Investment Advisors Corporation. The mutual fund scandal
started when Bank One, Bank of America, Janus, and Strong Capital came
under investigation for improper and/or illegal trading practices.

Every thing started when Bank One was named in a complaint brought by the
SEC and Eliot Spitzer’s office against Canary Capital Partners. Bank One was
the last of the four companies to reach a settlement with the SEC. Under
pressure to reach an agreement before the merger with J.P. Morgan Chase
took place, Bank One agreed to a $90 million settlement. Although the
company neither admitted nor denied wrongdoing, it agreed to pay $50 million
in fines and restitution, and reduce fees charged to investors in its mutual
funds by $40 million over the next five years. In addition, Mark Beeson, former
head of Bank One’s mutual fund division, agreed to pay a $100,000 fine. He
was also banned from the industry for two years. Bank One’s $90 million
settlement was considerably less than the $675 million in fines and restitution
that Bank of America/Fleet Boston paid for its role in the scandal. Like Bank
One, Bank of America reached an agreement with the SEC just before its
merger with Fleet Boston took place. Bank of America paid a higher price
because of a broader case in which one of its brokers faced criminal charges.
The scandal spread far beyond the four companies named in the complaint
against Canary Capital. Less than a year after the original charges were
brought, dozens of mutual fund companies had paid over $2.5 billion in fines,
restitution, and fee cuts.

Long known in the financial community for his integrity, Dimon addressed the
allegations of improper trading as soon as they became public in September
2003. Quickly, he developed a strategy that involved cooperation,
transparency, and communication to lead the bank out of the crisis. He
focused on “doing the right thing,” a value he consistently emphasized at the
bank. In a message to employees, Dimon wrote, “At Bank One we talk a lot
about doing the right thing, and I promise we will do the right thing in this
situation.” In the same message, Dimon outlined the steps that Bank One
would take to respond to the mutual fund scandal. Echoing the theme of doing
the right thing, Dimon wrote, “Nothing is more important to us than
maintaining the highest ethical standards.” He also emphasized that the bank
took its responsibility to shareholders very seriously. He mentioned that the
bank shared the interest of the New York Attorney General and regulators to
safeguard the integrity of the mutual fund industry. Dimon’s message to
employees established the major components of his strategy that were
followed throughout the crisis:

• Do the right thing


• Maintain the highest ethical standards
• Take the bank’s responsibility to mutual fund shareholders seriously
• Cooperate fully with the New York Attorney General and regulators
• Review and evaluate policies and procedures quickly and thoroughly
• Take disciplinary action as needed against employees
• Make restitution to shareholders
• Communicate and promote transparency

Dimon promised a swift and thorough gathering of the facts. In the interest of
transparency and communication, Dimon pledged to communicate with bank
employees and mutual fund shareholders as appropriate and encouraged
bank employees to share his letter with any Bank One customers who were
interested. However, Dimon requested employees to withhold comment or
speculation until the investigation uncovered the facts.

Overview of Bank One Investment Advisors


(BOIA)
Bank One Corporation’s wholly owned indirect subsidiary is Bank One
Investment Advisors (BOIA). BOIA offered investment management services,
including One Group Mutual Funds, to individuals and companies. One Group
Mutual Funds managed over $100 billion in assets.

BOIA, whose headquarters were in Columbus, OH, registered with the SEC
as an investment adviser on November 22, 1991. BOIA was a wholly owned
subsidiary of Bank One, National Association (Ohio), which in turn was a
wholly owned subsidiary of Bank One Corporation. Before its merger with J.P.
Morgan Chase & Co. on July 1, 2004, Bank One was the sixth largest bank in
the United States, with assets of around $320 billion.

Bank One served about 20,000 middle market clients and approximately
seven million retail households. The bank issued over 51 million credit cards
and managed investment assets of about $188 billion. On July 1, 2004, Bank
One merged with J.P. Morgan Chase & Co. The combined financial services
firm had assets of about $1.12 trillion. Operating in over 50 countries, the
company provided financial services for consumers and businesses,
investment banking, asset and wealth management, financial transaction
processing, and private equity. With corporate headquarters in New York, J.P.
Morgan Chase would maintain headquarters for U.S. retail financial services
and commercial banking in Chicago

The Scandel

On September 3, 2003, New York State Attorney General Eliot L. Spitzer and
the SEC brought charges against Canary Capital Partners, a hedge fund, for
illegal after-hours trading and improper market timing. In this complaint, Bank
One and three other mutual fund firms were named for making special deals
with Canary to conduct the improper mutual fund trades. Probes into mutual
fund trading focused on late trading and market timing. Late trading, an illegal
practice, occurs when mutual fund orders that are placed after 4 p.m. are
processed at the same day price rather than the price set on the following
day. Law requires that late trades be placed at the following day’s price.

Although market timing, also known as timing, is not illegal, many mutual fund
prospectuses discourage investors from doing it. Timing involves the rapid
buying and selling of mutual fund shares by short-term investors who try to
take advantage of inefficiencies in the pricing of mutual funds. Timers hope to
profit from fund share prices that lag behind the value of the underlying
securities. Share prices of mutual funds are set at 4 p.m. Eastern Standard
Time (EST) based on the values of their portfolio holdings. Any trades placed
after 4 p.m. EST are supposed to be charged at the next day’s prices to keep
investors from taking advantage of news that happens after the close of
trading. Like many other funds, One Group Mutual Funds had policies that
discouraged market timing, because it skimmed profits from the accounts of
other shareholders.

By giving special permission to certain large investors to market time, BOIA


earned higher management fees from those investors’ accounts. Market
timing could hurt long-term investors by driving up costs and reducing their
profits. The rapid in-and-out trading can cause an increase in transaction
costs since the portfolio manager may have to buy and sell securities in
response to the hedge fund’s trades. These costs are normally borne by the
mutual fund. In addition, the dilution effect occurs when the fund has to pay
for the timers’ profits out of its own finite pool of assets. The profits usually are
paid from the fund’s cash holdings or a sale of securities to cover the
payment. In either case, shareholders are hurt because the total amount of
assets available in the mutual fund is diminished. Some blame the practice of
market timing on stale pricing. Since mutual fund prices are only adjusted
once a day, they frequently go out of date, hence stale. The fund’s underlying
securities change value throughout the day, and may be spread across
different time zones.

Large investors can use sophisticated technology to take advantage of the


differences between the prices of the fund’s shares and the fund’s assets. The
effects of Canary’s market timing apparently took a toll on Bank One mutual
fund managers. According to the Canary settlement document, the managers
complained to One Group President Mark Beeson about the impact of
Canary’s timing activity on their funds. In April 2003, Canary stopped trading
in Bank One’s mutual funds when Beeson no longer felt comfortable waiving
penalties for their frequent trading.

One Group Restrictions against Timing

From June 2002 until May 2003, Mark A. Beeson and One Group allowed
Canary Capital to make 300 buy-and-sell transactions in several domestic and
international stock funds. Canary earned a profit of around $5.2 million from
this market timing. In addition, Canary was not charged around $4 million in
penalties that it should have paid for market timing.
Prospectuses in the One Group put restrictions on excessive exchange
activity in all the One Group mutual funds. Exchange of any investment in the
funds was limited to “two substantive exchange redemptions within 30 days of
each other.” In November 2001, One Group set a 2% early redemption fee for
any international fund redemption made within 90 days of purchase. In fact,
over 300 exchange privilege violations were identified by Beeson and BOIA
between January 2002 and September 2003

Late in 2001, Edward Stern, head of Canary Capital, made a proposal through
Security Trust Corporation to BOIA. He offered to borrow $25 million from
Bank One and match it with $25 million of his own funds if he were allowed to
trade in certain mutual funds. Beeson refused the proposal several times. But
after talking it over with Security Trust Corporation and Bank One employees,
Beeson decided to consider letting Stern trade in certain Bank One funds in
March 2002. Although Bank One’s chief operating officer advised against it,
Beeson allowed Edward Stern to trade in several domestic and two
international funds for up to half of one percent of the fund’s value. For trading
purposes, Bank One loaned $15 million to Stern, who matched it with his own
$15 million. Stern agreed that the entire amount would stay within Bank One
as security for the loan. BOIA did not charge Stern the 2% redemption fee
normally required for any trade made less than 90 days after an initial
purchase. This would have amounted to around $4.2 million in redemption
fees.

In January 2003, Stern received a second Bank One loan of $15 million,
which he again matched with $15 million of his own funds. He also used this
money to trade in One Group funds. Between June 2002 and April 2003,
Stern earned a net profit of about $5.2 million from approximately 300 in-and
out trades. From this arrangement, Bank One gained the interest on the loans
and BOIA increased mutual fund sales and associated fees. According to the
SEC settlement document, the agreements with Canary Capital were never
discussed with the One Group Board of Trustees. Another possible reason
why Beeson agreed to the arrangement was the hope of doing future
business with Stern. On several occasions, he discussed Stern’s possible
investment in a Bank One hedge fund, but that investment never took place.
Other customers besides Canary Capital received special treatment from
BOIA. Apparently without Beeson’s knowledge, a Texas hedge fund was
excused from paying the 2% redemption fee in March 2003. Although the
Texas company invested $43 million in two international funds and redeemed
the investment three days later, it did not have to pay about $840,000 in
redemption fees. BOIA did not reimburse the two international funds for the
fees that it didn’t collect. As standard procedure, the portfolio holdings of One
Group mutual funds were considered confidential information that was
published only as required by law. Nonetheless, Stern asked for and received
monthly updates on the eight funds in which he had investments from July
2002 until April 2003 when the relationship ended. Beeson provided him with
this information without any confidentiality agreement. The investigation also
found that BOIA provided One Group’s portfolio holdings to other special
clients over a period of ten years. This information was given out as often as
once a week to seven clients, eight prospective clients, and several dozen
consultants from pension funds or fund advisers.

The special trading arrangements for Stern and others began to unravel in
July 2003. Noreen Harrington, a former Hartz investments officer, blew the
whistle on improper trading practices at Canary Capital. She quoted Eddie
Stern as saying, “If I ever get in trouble, they’re not going to want me, they’re
going to want the mutual funds”. New York Attorney General Eliot Spitzer
subpoenaed Stern and named him in a complaint for having engaged in
“fraudulent” schemes of late trading and market timing of mutual funds. Two
months later, Canary Capital settled with the SEC and Attorney General’s
office for $40 million. Canary agreed to pay $30 million in restitution for profits
gained by improper trading, as well as a $10 million penalty. Canary neither
admitted nor denied wrong doing.

The Mutual Fund Industry

Shock waves hit Wall Street when Spitzer’s investigations began into trading
abuses in the mutual fund industry. As the probe continued, it uncovered
improper trading practices at dozens of mutual fund companies. Half of the 88
largest mutual fund groups had permitted favored investors to buy mutual
fund shares at stale prices, skimming profits from long-term shareholders.
Preferential trading for big investors was channeling billions of dollars away
from everyday long-term investors in mutual funds.

Pricing had been an issue in the mutual fund industry for a long time. In the
1930s, mutual funds often had two prices: a public price, as well as a more
up-to-date price that a few big investors could access just before the price
became public. The privileged investors who knew where mutual fund prices
were going could make fast profits. In response, Congress passed the
Investment Company Act of 1940 in an attempt to make mutual fund pricing
policies fairer. Among other rules, it required funds to have just one public
price. According to Mr. Spitzer, mutual fund companies made over $50 billion
in management fees in 2002. He was the first to suggest that the widespread
practice of preferential trading for big investors could be channeling billions of
dollars away from everyday long-term investors in mutual funds.

Mr. Spitzer commented on ways that companies could make amends. “If
they’re expecting to get settlements, they’re going to have to give much more
back than just losses. They’re going to be paying stiff fines and giving back
their management fees. They violated their trust with the American investor”.
Spitzer also expressed dissatisfaction with the SEC’s oversight of the
industry. Paul Roye headed the mutual fund division of the SEC. “Heads
should roll at the SEC. There is a whole division at the SEC that is supposed
to be looking at mutual funds. Where have they been?” According to SEC
Chairman William Donaldson, the SEC was considering new curbs on fund
trading. The question remained how the scandal would affect the mutual fund
industry. Arthur Levitt, former SEC chair, said, “This seems to be the most
egregious violation of the public trust of any of the events of recent years.
Investors may realize they can’t trust the bond market or they can’t trust a
stock broker or analysts, but mutual funds have been havens of security and
integrity”. How many of the 95 million customers would cash in their shares?
Investors apparently didn’t lose faith in all mutual funds. John C. Bogle,
founder of the Vanguard Group, believed that money was flowing out of
companies that had lost investor confidence and into companies that had kept
their good reputations for being well managed or holding down costs and
fees.

Indeed, stock funds gained $23.2 billion in December 2003, up from $14
billion in November 2003, according to AMG Data Services in Arcata,
California. More than half of the new money went into three funds which were
not implicated in the investigations: Fidelity, Vanguard, and American Funds.
As of November 2003, Putnam lost a net $11.1 billion from its stock funds,
while investors withdrew about $2.2 billion from Janus Capital’s stock funds.
Much of that may have been reinvested in other mutual funds.

Developments at Bank One


Bank One took a number of actions as the investigation progressed. Several
weeks after the probe began,Mark Beeson, the head of One Group, resigned.
Peter C. Marshall, Chairman of the Board of Trustees of One Group Mutual
Funds, sent a letter and prospectus supplement on October 10, 2003, to all
mutual fund customers informing them of the complaint filed by the New York
State Attorney General against Canary Capital Partners, LLC. The letter
included detailed information about legal proceedings related to the complaint
which found that Canary engaged in improper trading practices with certain
Bank One mutual funds.

In the letter Marshall wrote, “Nothing is more important to your Board than to
get all the facts and to resolve this matter as soon as possible”. He echoed
Jamie Dimon’s commitment to find out the facts quickly and do the right thing.
He informed shareholders that a special review committee had been created
to help gather and review information concerning the alleged trading activities.
He assured the shareholders that they would receive restitution if they had
been harmed by the wrongful conduct of any Bank One employee.
Furthermore, he made it clear that every member of the One Group Board of
Trustees was independent. As Jamie Dimon had done in September, Marshall
affirmed that the Board was committed to meeting the highest standards in
the industry and putting shareholders’ interests first. Shortly after Marshall’s
letter came out, Jamie Dimon sent an e-mail update to employees concerning
the mutual fund investigation. He summarized the key findings. Canary
Capital Partners hedge fund was allowed to trade eleven One Group funds
more often than other customers over an 11-month period ending in May,
2003. The investment by Canary averaged 0.5% of the fund’s assets and
never went over 1%. Dimon regretted the special arrangement with Canary
and stated that it never should have happened. The investigation into whether
shareholders were financially harmed was continuing. The bank would make
full restitution if it found this to be true. They would continue to see if other
clients had similar arrangements, but so far they had not found the problem to
be widespread or systemic. Bank One terminated its contract with Security
Trust Company, a back-office firm that processed Canary’s transactions in
One Group mutual funds. Although it was not accused of any wrongdoing in
Spitzer’s suit, the firm could not assure Bank One that they had abided by
their contract, which stated that the only trades that could be sent to One
Group for same-day pricing were those “received prior to market close.” No
evidence was found that Bank One or Bank One employees made after-
market trading arrangements.

Next, Dimon announced five changes that would strengthen oversight and
transparency of mutual fund policies and procedures at Bank One. First, Dave
Kundert took over as President of One Group. Second, the bank implemented
improved computer monitoring and compliance measures. Third, employees
would receive internal training on how to identify inappropriate timing
practices. Fourth, the bank enhanced agreements with service providers to
receive assurance that they had internal policies and controls to prevent going
around One Group’s policies concerning market timing and excessive trading.
Fifth, the bank continued to review mutual fund policies in order to meet the
highest standards. As he had done in a previous message, Dimon promoted
transparency and communication by encouraging employees to share his
letter with any Bank One customers who had questions. He also promised to
give additional updates as appropriate.
Taking the Matter Seriously

It was important for Bank One to convince the SEC, shareholders, and
customers that it was taking the charges seriously. As a result, this theme
appears in each public communication from the Bank. In Marshall’s letter to
One Group Shareholders, he emphasizes how seriously the Board of
Trustees is taking the matter. “On behalf of the One Group Board of Trustees,
I want to convey to you the seriousness with which your board takes its
responsibility to One Group mutual fund shareholders.” Dan McNeela, an
analyst for Morningstar, Inc., responded to Dimon’s personnel changes and
plans for change. “This confirms our opinion that Jamie Dimon is taking the
matter seriously, but it may not be enough simply to ask a couple of
executives to leave and say everything is okay”. Dave Kundert, President of
One Group Funds, addressed the mutual fund scandal at Bank One in a
message sent to employees on November 26, 2004. He explained that it was
likely that the bank would face enforcement action against Banc One
Investment Advisors. However, he expressed optimism that “we can avoid
regulatory litigation and reach an amicable resolution with the regulators over
the next several months.” Kundert outlined to employees the broad changes
in policies and procedures that Bank One had recently implemented in the
One Group mutual funds. They had established a 100% independent Board of
Trustees. They would continue to cooperate with the Attorney General’s and
SEC’s investigations. After holding a public dialog on best practices in the
industry, they selected and implemented a number of best practices which
included the following:

• Hiring a new compliance officer

• Increase training for employees

• Disclosure of more information about fund managers’ salaries

• Change how research fees are negotiated, paid, and disclosed to


investors

• Addition of redemption fees to certain funds

• Allow employees of the fund company to only buy One Group fund
shares through Banc One Securities Corp. accounts or One Group,
and require holding the One Group funds for at least 90 days

• Disclosure of portfolio holdings quarterly on the fund company’s Web


Site
• Cap individual purchases of Class B shares. These shares had a back-
end sales charge and higher expenses than Class A shares, which had
a front-end charge that declined as people invested more

Settlement Agreements

In the settlement agreement, Bank One agreed that Banc One Investment
Advisors would pay $10 million in restitution, as well as pay $40 million as a
penalty. The entire amount of $50 million would be paid to shareholders. It
would be placed in an escrow account to be distributed to eligible
shareholders through a plan created by an independent consultant and
approved by the SEC and One Group Board of Trustees. In addition, Banc
One Investment Advisors agreed to reduce advisory fees by $8 million per
year for five years.
Also BOIA would not raise advisory fees for five years. Mark Beeson, former
President and Chief Executive Officer of the One Group Mutual Funds unit of
Bank One, was banned for two years from the mutual fund industry and fined
$100,000 for his role in improper short-term trading.

On June 29, 2004, Banc One Investment Advisors agreed on a settlement


with the Securities and Exchange Commission and the New York Attorney
General’s office concerning issues related to One Group mutual fund trading.
The mutual fund unit of Bank One had “allowed improper short-term trading of
its fund shares at the expense of other shareholders.” According to Stephen
Cutler, director of the SEC’s division of enforcement, “Bank One and Mark
Beeson blatantly disregarded the well-being of One Group funds’ long-term
shareholders”. Bank One agreed to the settlement without admitting or
denying any wrongdoing. Philip Khinda, counsel to the One Group of funds
and their board of trustees, commented on the settlement agreement. “It’s a
very fair result and a product of the commitment of everyone involved to doing
right by the shareholders of the funds”. The Securities and Exchange
Commission found that Banc One Investment Advisors (BOIA) and Mark
Beeson, President and Chief Executive Officer of One Group Mutual Funds
and a senior managing director of BOIA, violated and/or aided and abetted or
caused violations of the antifraud provisions of the Advisers Act and the
Investment Company Act by the following:

1. Allowing excessive short-term trading in One Group funds by a hedge-


fund manager that was inconsistent with the terms of the funds’
prospectuses and that was potentially harmful to the funds.
2. Failing to disclose to the One Group Board of Trustees or to
shareholders the conflict of interest created when Respondents
entered into a market-timing arrangement with a hedge-fund manager
that was potentially harmful to One Group, but that would increase
BOIA’s advisory fees and potentially attract additional business.

3. Failing to charge the hedge-fund manager redemption fees as required


by the international funds’ prospectuses when other investors were
charged the redemption fees.

4. Having no written procedures in place to prevent the nonpublic


disclosure of One Group portfolio holdings and improperly providing
confidential portfolio holdings to the hedge-fund manager when
shareholders were not provided with or otherwise privy to the same
information.

5. Causing One Group funds, without the knowledge of the funds’


trustees, to participate in joint transactions, raising a conflict of interest
in violation of the Investment Company Act.
The Consequences

Peter C. Marshall, Chairman of the One Group Board of Trustees, explained


the settlement in an August 2004 letter to One Group Mutual Fund
shareholders. The prospectus that was enclosed with Marshall’s letter
outlined the steps that the bank would take to implement the settlement. The
One Group Mutual Funds Supplement that accompanied the letter informed
investors that they would receive a proportionate share of the money lost from
market-timing, as well as advisory fees paid by the affected funds during the
market-timing. Payment was expected to be made in 2005. The final lines of
the enclosed prospectus cautions shareholders that “It is possible, although
not likely, that these matters and/or related developments may result in
increased Fund redemptions and reduced sales of Fund shares, which could
result in increased costs and expenses or otherwise adversely affect the
Funds.” The outcomes of the settlements and reforms implemented by Bank
One, now J.P.Morgan Chase and Co., remained to be seen.

After the settlement, David J. Kundert, Chairman and CEO of Banc One
Investment Advisors, remarked, “Soon after we first learned of these
investigations, we committed to cooperate with regulators, make restitution to
shareholders, and review and change our policies as appropriate.

You might also like