The U.S. Securities and Exchange Commission reported today that a hedge fund and a former broker were subject to the first U.S. criminal charges for alleged deceptive market timing.

The SEC reported that Beacon Rock Capital LLC, a hedge fund located in Portland, Oregon, and a former securities registered representative with a registered broker-dealer based in Philadelphia, were criminally charged in connection with an alleged scheme to defraud mutual funds and their shareholders of approximately US$2.4 million. The allegations have not been proven.

In an Information filed on March 20, the U.S. Attorney for the Eastern District of Pennsylvania charged that Beacon Rock and the broker engaged in a scheme to evade and circumvent controls implemented by mutual funds seeking to restrict market timing, or a mutual fund trading strategy generally involving short-term purchases and sales of mutual fund shares. This is the first U.S. criminal case against a hedge fund for deceptive market timing.

According to the Information, from December 1999 through November 2003, the broker provided brokerage services to Beacon Rock. It claims that the primary purpose of this relationship was to permit Beacon Rock, whose primary trading strategies involved market timing, to evade and circumvent controls implemented by mutual funds seeking to restrict market timing or other excessive trading. It alleges that Beacon Rock and the broker were aware that market timing was unwanted and potentially harmful to mutual fund shareholders, and that the mutual funds would not permit such trades. Nevertheless, it claims that they engaged in a number of deceptive and fraudulent practices designed to conceal the identity of Beacon Rock and the nature of its trading activity.

The Information charges that Beacon Rock made in excess of 26,000 market timing trades, resulting in approximately US$2.4 million in net trading profits; and that the broker earned approximately US$215,000 in compensation as a direct result of the illegal trading.

The U.S. Attorney charged the fund and the broker with securities fraud.

The SEC filed a civil injunctive action in 2005 against the broker and another defendant. On March 30, 2006, the federal district court for the Eastern District of Pennsylvania entered a final judgment by consent in the civil action, permanently enjoining him from further violations, and ordering him to pay disgorgement of US$540,044, but waiving payment of all but US$100,000. The court did not impose a civil penalty, based on his sworn financial statements submitted to the commission. Also, in 2006, the SEC issued an order barring him from association with any broker or dealer. This administrative order was based on the permanent injunction entered in the civil action.