US funds scandal will rock City

BRITAIN'S financial watchdogs fear that the latest scandal to rock America could have spread across the Atlantic.

Employees at America's biggest banks have been caught up in criminal investigations aimed at rooting out a scandal in mutual funds known as 'market timing' and 'late trading'.

Now the Financial Services Authority is conducting a 'global review' of unit trusts - Britain's equivalent of mutual funds - to check whether the UK regulations need tightening.

Meanwhile, the industry's trade body, the Investment Manager's Association, said it knew that some unscrupulous firms had tried to mimic the American offences in Britain's £220 billion unit trust business.

The IMA said: 'We've been alerted by our members to some people wanting to do market timing in this country and they have refused.'

But one industry source said it was inconceivable that some of this trading did not happen. He said: 'Of course it goes on over here. The only question is, how much?'

Unit trusts and mutual funds are long-term investments used by millions to play the stock markets, but market timing and late trading are techniques for quick and often illegal buying and selling of funds.

The effect can be to allow a firm to trade far faster than ordinary investors, reap profits unavailable to individuals and even make guaranteed profits by illegally trading when most investors cannot.

Unit trusts and mutual funds are investments that contain a basket of shares or other investments. Their price rises or falls according to changes in the value of the separate shares. But often there is a time lag between the movement of actual share prices and the change in price of the unit trust or mutual fund.

Market timing involves rapid trading in the funds to take advantage of this time lag. Ordinary investors cannot trade as fast and are often sold unit trusts on the premise that they are insulated from the frenetic trading of individual shares.

Late trading allows an investor to buy after the stock market has closed. Because funds often contain shares in overseas companies, the closing price of the unit can easily be out of line with the real value of the shares and will catch up only when trading resumes the following morning.

This allows a firm to buy into a fund with the certain knowledge that it will rise in value when the market reopens. It is illegal in America and Britain.

In the US, market timing is illegal when a fund's prospectus states that its policy is not to allow rapid trading by sharp investors.

In Britain, the IMA said the practice was almost certainly outlawed by Financial Services Authority rules, which require firms to care equally for the interests of all their customers.

The US investigation, headed by the uncompromising New York State Attorney-General Eliot Spitzer, has implicated staff at most of the big banks, including Bank of America, Bear Stearns, Charles Schwab, Citigroup and Merrill Lynch. All have sacked staff for activities relating to mutual funds.

Two British firms have also been investigated. The finger has been pointed at Old Mutual's US subsidiary, Pilgrim Baxter & Associates, which has fired founders Gary Pilgrim and Harold Baxter. Both face legal claims in the US courts. Meanwhile, Amvescap has confirmed that its Denver-based business Invesco expects to face civil actions over market timing in mutual funds. The claims were less severe than many had feared and Amvescap shares rose last week, but the stock is still down 27% since September when Spitzer started naming offenders in the US.

Old Mutual said: 'There was no indication that any of these practices has taken place in Old Mutual in the UK.'

Amvescap said it believed it had carried out its own inquiries into its UK business and found no evidence of market timing or late trading.