Bear Stearns Cos. on Thursday became the third brokerage in as many days to post record first-quarter earnings and revenues, but the good news was overshadowed by old problems — illegal market timing practices that bilked mutual fund investors out of millions.
The New York Stock Exchange and Securities and Exchange Commission announced Thursday that they fined Bear Stearns $250 million — nearly half of its profits for the first quarter — for illegally helping hedge funds and other customers trade mutual fund shares. It was the biggest settlement ever reached by the NYSE’s regulatory arm.
Bear Stearns settled the case without admitting or denying the charges. The company will pay $90 million in fines and relinquish $160 million in profits and interest, and the entire $250 million will go back to investors, regulators said.
The brokerage had disclosed a tentative settlement and fine in December, and the company has already set aside the money necessary to cover the settlement costs, so there will be no negative impact on current or future earnings.
Nonetheless, investors bid the brokerage’s stock lower Thursday as details of the case came out. Shares of Bear Stearns fell 94 cents, to close at $133.27 on the NYSE, having given back all of the 2.2 percent advance the stock had seen in the first minutes of trading due to its record profits.
According to NYSE Regulation, Bear Stearns engaged in a pattern of deceptive market timing and late trading of fund shares from 1999 through 2003. The trades were designed to take advantage of the time between the markets’ closing and the new share values posted by mutual fund companies. Bear Stearns brokers would process trades after the market closed, giving customers better prices than they would have gotten once the share price of the funds was recalculated.
Bear Stearns employees also falsified records to hide large mutual fund timing trades, and worked to mislead mutual fund companies about the size and scope of the company’s market timing efforts, according to Susan Merrill, head of NYSE Regulation’s enforcement arm.
“The size of the fine and the disgorgement, reflects the fact that there were many long-term holders of mutual funds that were affected by this conduct, which was an outright fraud,” Merrill said. “Its sending a message that our member firms that commit fraud, fraud that has an impact on customers, will be dealt with in the harshest way possible.”
In NYSE Regulation’s hearing report, numerous examples of institutionalized deceptive trading practices were laid bare. One broker was recorded telling others to falsify the time stamps on trading reports so that they appeared to be filed before the 4 p.m. EST close of the markets. “Because you’re sending down trades after what’s considered a legitimate time ... we need to populate a time prior to 4 p.m. New York time,” one trader was recorded saying, according to regulators.
In addition to the fine and profit repayment, Bear Stearns must hire a consultant to review compliance procedures at the company, and another consultant to administer the fine and give back the relinquished profits to mutual fund investors. The company must also improve its internal compliance efforts, and the presidents of the divisions involved must personally sign off on reports to regulators.
The news came just as Bear Stearns Chief Financial Officer Sam Molinaro prepared to discuss the company’s record earnings for the first quarter in a conference call with analysts Thursday morning. For the quarter ending Feb. 28, Bear Stearns earned $508.7 million, or $3.54 per share, compared to $372.3 million, or $2.64 per share, in the first quarter of 2005.
Revenue rose 18.9 percent to $2.19 billion compared to $1.84 billion a year ago.
Analysts surveyed by Thomson Financial had expected the company to earn $2.95 per share on revenue of $2.05 billion.
Bear Stearns saw record revenue in its capital markets division, especially in equities trading and investment banking, as well as its wealth management arm, which includes private client accounts and asset management products.
However, Bear Stearns’ clearing services division, which aids institutional investors and other brokerages in stock transactions, posted a 2 percent decline in revenue to $270 million. Molinaro blamed the lost on shifting strategies by Bear Stearns’ clearing clients that led to lower fee income.
The brokerage’s board of directors declared a regular quarterly cash dividend of 28 cents per share, payable April 28 to shareholders of record on April 18. Molinaro said the company did not expect to increase its share repurchase program. The company spent $476 million in the quarter to repurchase 4.1 million shares, he said.
Bear Stearns’ earnings come after Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc. both posted record first quarter income and revenues earlier in the week.