The NASD has brought the first market timing case against a broker involving variable annuities.

The U.S. association that regulates securities dealers announced today that it has fined Davenport & Co. LLC US$450,000 and ordered the company to pay more than US$288,000 in restitution to the affected funds.

The fine includes punishment for Davenport’s failure to establish and maintain a reasonable supervisory system and written supervisory procedures designed to prevent late trading of mutual funds.

From at least April 2002 through September 2003, Davenport helped two hedge funds carry out deceptive market timing in the sub-accounts of variable annuities, the NASD said. The brokers handling the accounts and managers at the firm were aware that the clients were engaging in market timing techniques and that the annuities’ prospectuses stated that they were designed for long-term investors, and not for professional market timers. Nevertheless, Davenport enabled these clients to carry out frequent transfers among variable annuity sub-accounts without being detected by the affected insurance companies and mutual fund managers, who were attempting to enforce restrictions on market timing to protect the interests of long-term investors.

Davenport continued to sell variable annuity policies to the clients’ investment partnerships even after receiving notice that some of the variable annuity companies considered the clients’ trading strategy to be disruptive and contrary to the interests of long-term investors. As a result, Davenport’s clients were able to realize profits in excess of US$288,000, at the expense of long-term investors.

Davenport similarly facilitated deceptive practices by its hedge fund clients regarding variable annuities offered by other insurance companies, agreeing to change the annuitants, brokers of record, or the particular name of the hedge fund on the account in order to evade the attempts of the insurance companies and mutual funds to detect and prevent excessive market timing. The hedge funds involved were not named by the NASD.

“Deceptive market timing in variable annuity sub-accounts can dilute the value of those shares, raise transaction costs and thus harm other annuity investors,” said Mary Schapiro, vice chairman of NASD. “This is an improper and objectionable trading practice that rises to a higher level of abuse when the firm not only knows that its clients intend to deceive the variable annuity companies, but is complicit in carrying out that deception.”