New York attorney general Eliot Spitzer announced Wednesday that his office has obtained evidence of widespread illegal trading schemes that potentially cost mutual fund shareholders billions of dollars annually.

Spitzer’s office began an investigation of mutual fund trading practices earlier this year. That investigation quickly became focused on practices known as “late trading” and “market timing.”

“Late trading” involves purchasing mutual fund shares at the 16:00 ET price after the market closes. “Allowing late trading is like allowing betting on a horse race after the horses have crossed the finish line,” said Spitzer.

“Timing” is an investment technique involving short-term, “in and out” trading of mutual fund shares, which has a detrimental effect on the long-term shareholders for whom mutual fund investors are designed. The technique is designed to exploit market inefficiencies when the “net asset value” of the mutual fund shares — which is set at the market close — does not reflect the current market value of the stocks held by the mutual fund.

Spitzer said that evidence uncovered by his office shows that mutual fund managers permitted favored individuals and companies to engage in such trading in exchange for payments and other inducements. “Allowing timing is like a casino saying that it prohibits loaded dice, but then allowing favored gamblers to use loaded dice, in return for a piece of the action,” said Spitzer.

Spitzer announced that one of the perpetrators of the schemes – a hedge fund and its managers, Canary Capital Partners -has agreed to make restitution US$30 million in illegal profits generated from unlawful trading and pay a US$10 million penalty. The agreement further commits the hedge fund and its officers and employees to continue to cooperate in the ongoing investigation of the mutual fund industry.

“The full extent of this complicated fraud is not yet known,” Spitzer said. “But one thing is clear: The mutual fund industry operates on a double standard. Certain companies and individuals have been given the opportunity to manipulate the system.”

Spitzer added that his office will take all reasonable steps to ensure that the ill-gotten gains of those who engage in this conduct are returned to investors, that wrongdoers are held responsible, and that appropriate reforms are implemented to halt this egregious activity,” he said.