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Bank of America expands restitution

Bank of America will form a restitution fund for shareholders of its Nations Funds who lost millions of dollars because of alleged improper trading that gave a hedge fund unfair advantages.
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Bank of America Corp., struggling to rebuild its reputation after a mutual-fund scandal, broadened an offer of restitution Tuesday and said it has hired outside experts to review its policies and practices. The announcement came a day after Fidelity Investments, the nation’s largest mutual fund company, said it received a demand for information from New York Attorney General Eliot Spitzer, who has been spearheading an investigation into the industry.

Bank of America, which already had promised to make restitution for any harm suffered by investors in its Nations Fund mutual funds, now has extended that promise to owners of third-party funds that might have been victimized in the scandal.

“Nothing is more important in our business than the trust and confidence of our customers and clients,” chairman and chief executive officer Ken Lewis said in announcing the bank company’s plans for a restitution fund.

A Bank of America spokesman said the amount of restitution has yet to be determined, but he said some details of the financial impact of the scandal might be disclosed along with the company’s earnings next week.

Bank of America and its former broker Theodore Sihpol III are central to allegations of improper market timing and late trading by New York investor Edward Stern and his Canary Capital Management hedge fund.

While Spitzer has charged that three other fund companies allowed Canary to execute timing strategies, despite published policies that prohibit the practice, only Nations Funds has been linked to the practice of late trading, which is illegal.

Sihpol has been dismissed by Bank of America and faces criminal charges of larceny and securities law violations.

In addition to permitting improper trades at Nations Funds in exchange for Stern’s business, Bank of America allegedly allowed Canary to use its proprietary trading platform to execute trades. Usually Bank of America makes the platform available not to individual investors or hedge funds but only to registered broker-dealers who lack direct trading access, said Bob Stickler, a spokesman for the Charlotte, N.C.-based banking giant.

The fact that Canary had access to the trading platform raises the possibility that other funds might have been victimized by market timing or even late trading.

Under the latest offer Bank of America will make restitution to shareholders of such third-party mutual funds who were harmed if Canary, its affiliates or others fail to make them whole. Stickler said the promise makes Bank of America the source of “restitution of last resort” for the injured mutual-fund holders.

Wide-ranging probe

Last month Canary and its managers agreed to pay $30 million in restitution for profits generated from improper trading and a $10 million penalty to settle Spitzer’s allegations. Canary neither admitted nor denied wrongdoing.

Janus Capital Group also has said it would return about $1 million in fees it made from short-term trading with Canary. Strong Capital Management and Bank One Corp. also allegedly permitted Canary to execute market timing strategies, which generally are prohibited by mutual fund companies because they increase costs to long-term investors.

The charges against Canary have opened the floodgates to a wide-ranging investigation of the industry, and so observers said Tuesday they were not surprised to learn that Fidelity had been subpoenaed.

“We received a subpoena late last week requesting information on market timing and late trading,” said Anne Crowley, a Fidelity spokeswoman. “We will fully cooperate with all of the attorney general’s requests.”

A spokeswoman for Spitzer’s office declined to comment.

Jason Greene, a finance professor at Georgia State University, cautioned against reading anything into the fact that Fidelity had been ordered to provide information.

“It might be to see if they were victims just as much to see if they were somehow involved in some kind of wrongdoing,” he said.

While mutual fund companies generally are responsible for knowing who they do business with, it is possible that Canary or other investors were able to hide their identities because they had access to a direct trading platform.

Hostility to timers

Fidelity is well-known for having extensive policies aimed at foiling short-term traders who try to profit through timing, said Russ Kinnel, a senior analyst at Morningstar who follows the mutual-fund industry.

“They have gone to great lengths to keep timers out,” said Kinnel.

For example Fidelity charges high exit fees to short-term traders in many of its funds, making it nearly impossible to profit from temporary price differences that might be caused, for example, by “stale” pricing of overseas stocks. Fidelity’s biggest rival, Vanguard, also is known for its hostility to market timers. Vanguard announced in early September that it had received a subpoena from Spitzer and is cooperating with the probe.

In addition to the expanded restitution offer, Bank of America said it has hired Dale Frey, former chairman of General Electric Investment Corp., to handle an independent review of the bank’s mutual fund policies and practices.

Maureen Scannell Bateman, a former general counsel of State Street Corp. and U.S. Trust, will conduct a legal review of the funds, Lewis said.

Promontory Financial Group has been retained to coordinate a detailed review of all technology, control, and compliance systems related to the mutual fund business. The review will include all systems relating to sales, clearing, and derivative and brokerage operations.

In addition to the investigations under way in New York and at the federal level, Massachusetts Secretary of State William F. Galvin has launched investigations of financial services firms including Prudential Securities and Putnam Investments.

Meanwhile, a growing list of mutual fund companies have fired or suspended employees following internal investigations of trading activities. Merrill Lynch & Co., Alliance Capital Management and Prudential have suspended or fired a total of at least 17 employees.

The Associated Press and Reuters contributed to this report.