Exhibit 10.5

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NYSE HEARING BOARD DECISION 06-156    August 18, 2006 PRUDENTIAL EQUITY GROUP,
LLC    MEMBER ORGANIZATION   

*    *    *

Violated Section 10(b) of Securities Exchange Act of 1934, Rule 10b-5
thereunder, and NYSE Rule 476(a)(5) by using means or instrumentality of
facility on national securities exchange, in connection with purchase or sale of
security, to defraud, make untrue statement of material fact, or engage in act,
practice, or course of business which operates as fraud or deceit; violated
Section 17(a) of Securities Exchange Act of 1934 and Rules 17a-3 and 17a-4
thereunder by failing to make and keep accurate books and records, including
trade blotters and trade tickets; violated NYSE Rules 401 and 476(a)(6) by
allowing certain brokers to engage in deceptive practices related to market
timing of mutual funds; violated NYSE Rule 342 by failing to reasonably
supervise its business activities and to establish and maintain appropriate
procedures for supervision and control with respect to its business activities
involving trading of mutual funds – Consent to censure, $270 million
disgorgement, and undertakings.

Appearances:

 

For the Division of Enforcement    For Respondent Susan Light, Esq.    Gail
Marshall-Smith, Esq. Margaret Tolan, Esq.    Neil Sullivan, Esq.

*    *    *

A Hearing Officer on behalf of the New York Stock Exchange LLC (“NYSE”)
considered a Stipulation of Facts and Consent to Penalty entered into between
NYSE Regulation, Inc.’s Division of Enforcement (“Enforcement”) and Prudential
Equity Group, LLC, formerly known as Prudential Securities, Inc. (“Respondent,”
“PSI,” or the “Firm”), an NYSE member organization. Without admitting or denying
guilt, Respondent consented to a finding by the Hearing Officer that it:

 

  I.

Willfully violated Section 10(b) of the Securities Exchange Act of 1934 [15
U.S.C. section 78j(b)] (the “Exchange Act”), Rule 10b-5 thereunder [17 C.F.R.
section 240.10b-5], and NYSE Rule 476(a)(5) by using any means or
instrumentality of interstate commerce or of the mails, or of any facility on
any national securities

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exchange, in connection with the purchase or sale of any security, to employ any
device, scheme, or artifice to defraud, to make any untrue statement of a
material fact or to omit to state a material fact necessary in order to make the
statements made, in the light of the circumstances under which they were made,
not misleading, or to engage in any act, practice, or course of business which
operates or would operate as a fraud or deceit upon any person.

 

  II. Failed to make and keep required books and records in violation of
Section 17(a) of the Exchange Act. Section 17(a)(1) of the Exchange Act required
PSI to make and keep current certain specified books and records relating to its
business. Implicit in the U.S. Securities and Exchange Commission’s (the
“Commission”) recordkeeping rules is a requirement that information contained in
a required book or record be accurate. Rules 17a-3 and 17a-4 enumerate those
records required to be maintained, including trade blotters and trade tickets.
PSI failed to maintain complete and current copies of trade blotters concerning
mutual fund trading and trade tickets related to mutual fund trading in a
readily accessible place. In instances where PSI did maintain trade tickets,
information included on them did not represent the actual time at which the
orders were placed.

 

  III. Violated NYSE Rule 476(a)(6) in that it engaged in conduct inconsistent
with just and equitable principles of trade by allowing certain of its brokers
to engage in deceptive practices related to the market timing of mutual funds

 

  IV. Violated NYSE Rule 401 in that it failed to adhere to the principles of
good business practice by allowing certain of its brokers to engage in deceptive
practices related to the market timing of mutual funds.

 

  V. Violated NYSE Rule 342 by failing to reasonably supervise its business
activities, and to establish and maintain appropriate procedures for supervision
and control with respect to its business activities involving the trading of
mutual funds.

For the sole purpose of settling this disciplinary proceeding, Enforcement and
Respondent stipulate to certain facts,* the substance of which follows:1

Background and Jurisdiction

 

  1. PSI was a member organization of the NYSE and maintained its headquarters
and principal place of business in New York. Prior to July 1, 2003, PSI was an
indirect wholly-owned broker-dealer subsidiary of Prudential Financial, Inc.
(“Prudential

 

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* Hearing Officer Note: The facts, allegations, and conclusions contained in
paragraphs 1 to 45 are taken from the executed Stipulation of Facts and Consent
to Penalty between Enforcement and Respondent. No changes have been made to the
stipulated paragraphs by the Hearing Officer.

1 The findings made herein are not binding on Respondent or any other Prudential
Financial, Inc. entity in any other forum, nor are the findings binding on any
other person or entity.

 

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Financial”). Prudential Financial is a publicly-owned holding company, traded on
the New York Stock Exchange, whose operating subsidiaries provide a wide range
of insurance, investment management and other financial products and services to
retail and institutional customers including insurance brokers and investment
managers. On July 1, 2003, PSI transferred the assets relating to its U.S.
retail securities brokerage operations to a newly formed holding company, now
named Wachovia Securities Financial Holdings, LLC (“WSFH”). Prudential Financial
presently owns 38% of WSFH and Wachovia Corporation owns 62% of WSFH. Since
July 1, 2003, PSI’s former U.S. retail securities brokerage business has
operated as part of Wachovia Securities, LLC. Following the asset transfer, PSI
converted from a stock corporation into a limited liability company and was
renamed Prudential Equity Group, LLC (“PEG”). PEG is a broker-dealer registered
with the Commission pursuant to Section 15(b) of the Exchange Act and is a
member of the National Association of Securities Dealers and the New York Stock
Exchange. PEG provides equity research, sales and trading to domestic and
international institutional customers and is a successor entity to PSI.
Prudential Financial continues to own 100% of the equity interests in PEG.

 

  2. On or about October of 2003, Enforcement notified Respondent of its
investigation into possible violative conduct involving the market timing of
mutual funds by certain of Respondent’s registered representatives and of its
supervision of its mutual fund trading business.

Summary

 

  3. This matter concerns a fraudulent market timing scheme perpetrated by PSI
registered representatives (collectively, the “Brokers”) whose business involved
market timing to defraud at least fifty mutual funds and their long term
shareholders. Beginning in at least September 1999 and continuing through at
least June 2003 (the “Relevant Period”), the Brokers used deceptive trading
practices to conceal their identities, and those of their customers, to evade
mutual funds’ prospectus limitations on market timing. These practices included
the use of multiple broker identifying numbers (known as Financial Advisor, or
“FA” numbers) and multiple customer accounts; the use of accounts coded as
confidential in PSI’s systems; and the Brokers’ use of “under the radar” trading
to avoid notice by mutual funds. Typically, mutual funds screened for market
timing trades only above a designated dollar amount. The practice of “under the
radar” trading refers to the Brokers’ splitting of one trade into numerous
smaller ones to avoid detection by mutual funds.

 

  4. As early as the fourth quarter 1999, several mutual fund companies
identified the Brokers’ use of deceptive trading practices and notified PSI of
the Brokers’ conduct. In May 2002, PSI itself determined that its top-producing
broker used deceptive trading practices to avoid notice by mutual funds.
Throughout the Relevant Period, PSI received hundreds of notices from mutual
fund companies that identified the Brokers’ conduct and asked the Firm to take
steps to curtail their deceptive market timing practices.

 

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  5. Despite PSI’s increasing awareness of the Brokers’ fraudulent market timing
practices, the Firm elected to continue the business of market timing. Rather
than discipline or sanction any of the Brokers or even curtail their ability to
open additional accounts for their market timing customers, PSI failed to
prevent their conduct from continuing and actually began to track the Brokers’
gross revenues. In 2001, for example, the Brokers generated more than $16
million in gross commission revenues for the Firm, most of which was in danger
of being eliminated had the Firm phased out market timing at that time.
Similarly, the Brokers generated approximately $23 million in gross commission
revenues in 2002, and continued to generate comparable revenues throughout the
Relevant Period.

 

  6. PSI’s policies and procedures were ineffective in curtailing the Brokers’
fraud and were largely not enforced. Even in situations where PSI purportedly
enforced any of these policies, PSI senior officers undermined them by granting
exceptions for PSI’s largest producing brokers. Additionally, PSI repeatedly
failed to deprive the Brokers of their inappropriate use of hundreds of FA
numbers, even though the use of multiple FA numbers was the primary means by
which the Brokers carried out their fraud. PSI finally issued a market timing
policy in January 2003, but the Firm did not fully enforce procedures in that
policy to curtail the Brokers’ scheme. As a result of the conduct described
above, PSI violated the antifraud and books and records provisions of the
federal securities laws, and NYSE Rules 401, 476(a)(5)-(6), 440 and 342, which
relate to good business practices, just and equitable principles of trade, NYSE
books and records requirements and failure to supervise.

Background

 

  7. Market timing includes frequent buying and selling of shares of the same
mutual fund or buying or selling of mutual fund shares in order to exploit
inefficiencies in mutual fund pricing. Though not illegal per se, market timing
can harm mutual fund shareholders because it can dilute the value of their
shares, if the market timer is exploiting pricing inefficiencies, or disrupt the
management of the mutual fund’s investment portfolio and can cause the targeted
mutual fund to incur costs borne by other shareholders to accommodate frequent
buying and selling of shares by the market timer.

 

  8. Beginning in the late 1990s, many mutual funds determined that market
timing harmed their long-term shareholders. As a result, they began to monitor
market timing in their funds’ shares and imposed restrictions on excessive
trading. Such restrictions limited the number of trades that an account holder
could place in a fund’s shares and often were set forth in the funds’
prospectuses. Many funds monitored trading activity to detect any violations of
these prospectus limitations.

 

  9.

Most mutual funds received trade instructions from PSI through the National
Securities Clearing Corporation (“NSCC”). NSCC is a centralized trade clearance
and settlement system that linked the Brokers, PSI, and virtually all mutual
fund

 

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companies. To place trades that were transmitted through NSCC, the Brokers were
required to identify their FA number and a customer account to mutual funds on
trade tickets. PSI appended additional information to the Brokers’ orders and
transmitted the transactions through NSCC to the mutual fund companies.

 

  10. Some mutual funds screened for excessive short -term trading by reviewing
FA and customer account numbers that the Brokers transmitted to them via NSCC.
Some also monitored for excessive short -term trading by trade size and
principal amount and by the branch code attached to a trade.2 Typically, if a
fund concluded that a shareholder had violated its exchange limitations, the
fund would attempt to prevent, or “block” additional trades in a fund or fund
family by that shareholder. If a fund determined that a particular PSI broker or
shareholder had violated its exchange limitations, the fund would send a “block
letter” to PSI. Block letters varied but generally notified PSI of the mutual
fund’s intention to block the broker or customer’s transaction and often asked
PSI to take steps to preclude a particular broker or customer account from
engaging in additional trades in a particular fund or fund family.

 

  11. Because these mutual funds monitored for excessive trading by FA number
and/or customer account number, the Brokers altered their use of these numbers
to defraud these funds and the funds’ long-term shareholders. By altering their
use of these numbers, the Brokers tricked mutual fund companies into accepting
trades that the funds otherwise would have rejected.

The Brokers’ Deceptive Conduct

 

  12. During the Relevant Period, the Brokers engaged in a fraudulent scheme to
circumvent blocks imposed by mutual funds on their trading privileges. The
Brokers’ scheme worked as follows. The Brokers’ customers, typically hedge
funds, asked the Brokers to purchase and sell mutual funds on a short-term basis
on their behalf. The Brokers, however, knew that mutual funds tracked their
trades by FA number and customer account number, and they knew that if they
placed short-term mutual fund trades for their customers using a single FA or
account number, the mutual funds would likely determine the number of trades was
excessive and would block any further trades by them.

 

  13. The Brokers, therefore, devised a scheme to conduct their customers’
trading using dozens of customer accounts, often established under fictitious
names, and multiple FA numbers to make it difficult for mutual funds to identify
their customers’ market timing. When the mutual funds succeeded in blocking
certain FA numbers or customer accounts from further trading, the Brokers then
used other FA numbers and customer accounts that had not yet been blocked to
evade the funds’ restrictions and continue to trade.

 

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2 PSI assigned branch codes to each of its retail branch offices. Branch codes
identified to mutual funds the PSI branch office from which a particular market
timing trade originated.

 

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The Boston Brokers

 

  14. For example, one group of PSI brokers based in its Boston, Massachusetts
branch office (the “Boston Brokers”) repeatedly used these deceptive practices
to defraud mutual funds throughout the Relevant Period. The Boston Brokers
consisted of a group of three PSI brokers and several registered assistants. The
group had five customers for whom it placed market timing trades, each of whom
acted on behalf of one or more hedge funds. During the Relevant Period, PSI
received approximately $8 million from the Boston Brokers’ market timing
activities, of which group members received approximately $4.6 million. As a
result of this business, the head of the group quickly rose to become one of
PSI’s top producers.

 

  15. Many of the mutual funds in which the Boston Brokers traded screened for
market timing trades by FA and customer account numbers. Many fund companies
sent notices to PSI that complained that the group’s trades had violated
prospectus limitations. Some mutual funds announced steps they had taken to
preclude the Boston Brokers from further trading while others asked that PSI
take steps to block further trades by the group in the fund.

 

  16. During the Relevant Period, the Boston Brokers used at least thirteen FA
numbers and hundreds of customer accounts (for what were, in reality, only five
customers) to circumvent these blocks and preclude new blocks. The Boston
Brokers’ use of these devices in connection with market timing allowed group
members to continue to place trades in funds that had taken steps to preclude
them from further trading. This scheme created the impression that transactions
originated from many brokers and represented many different customers. In fact,
what appeared to the mutual funds to be thousands of separate transactions
submitted by many brokers for many unrelated customers was actually a systematic
pattern of market timing by group members on behalf of their five hedge fund
customers.

The Garden City Broker

 

  17. Another PSI broker based in its Liberty Plaza and Garden City, New York
branch offices (the “Garden City Broker”) used these same deceptive practices to
defraud mutual funds throughout the Relevant Period. The Garden City Broker
headed a team of brokers and registered assistants, although he very rarely
reported to work at any PSI location. He had five customers for whom he placed
market timing trades, each of whom acted on behalf of one or more hedge funds.
During the Relevant Period, PSI received approximately $9.8 million from the
Garden City Broker’s market timing activities (of which the Garden City Broker
received approximately $4.7 million). The Garden City Broker was the top
producing broker at PSI throughout the Relevant Period.

 

  18. Like the Boston Brokers, the Garden City Broker traded in mutual funds
that screened for market timing by FA and customer account number. During the
Relevant Period, approximately fifty mutual funds complained to PSI about the
Garden City Broker’s trading activity. Many mutual funds specifically identified
to PSI his use of deceptive trading strategies to evade blocks the fund
companies had imposed.

 

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  19. To evade these blocks, the Garden City Broker maintained 49 different FA
numbers and hundreds of customer account numbers (for what were, in reality,
only five customers). His use of these devices to market time created the
impression that the trades originated from many brokers and many customers. By
shifting trades from one FA number to another, or from one customer account to
another, the Garden City Broker concealed his identity and was able to place
trades in mutual funds where PSI previously had blocked his trading under his
other FA numbers and accounts.

The Special Accounts Brokers

 

  20. Another group of PSI brokers based in a New York office known within the
Firm as “Special Accounts” (the “Special Accounts Brokers”) also used deceptive
practices to defraud mutual funds throughout the Relevant Period. The Special
Accounts Brokers consisted of a group of two PSI brokers and several registered
assistants. The group had three customers for which it placed market timing
trades. During the Relevant Period, PSI received approximately $6.5 million from
the Special Accounts Brokers’ market timing activities, of which group members
received approximately $2.5 million. As a result of this business, the heads of
the group quickly achieved membership in PSI’s Chairman’s Club, a select group
consisting of the largest producing brokers within the Firm.

 

  21. Like the Boston Brokers and the Garden City Broker, the Special Accounts
Brokers knew that most mutual funds identified excessive trading by FA and
customer account number. They also understood that mutual funds screened for
market timing by reviewing only those trades at or exceeding certain dollar
amounts. The Special Accounts Brokers used at least 20 FA numbers and hundreds
of customer accounts (for what were, in reality, only three customers) to avoid
detection by mutual funds. The Special Accounts Brokers also used “under the
radar” trading to disguise their customers’ trading in funds that previously had
taken steps to stop them. The brokers’ use of these devices in connection with
market timing deceived mutual funds into accepting trades they otherwise would
have rejected. Like the Boston Brokers and the Garden City Broker, their scheme
perpetuated the impression that transactions originated from many brokers and
represented many different customers.

PSI Failed to Prevent the Brokers From Obtaining Multiple Broker

Identification and Customer Account Numbers

 

  22.

PSI failed to prevent the Brokers from obtaining several different forms of
broker identifying numbers. Consequently, the Brokers used these numbers to
perpetrate their scheme to defraud. When brokers began their employment with
PSI, PSI assigned them an FA number. The Brokers used FA numbers to open
customer accounts, execute trades, and track their commissions. When brokers
worked as a team to service common customers, PSI provided “Joint” numbers.
Joint numbers

 

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ostensibly represented a commission split between two or more brokers. Here, the
Brokers acquired and used Joint numbers for improper purposes. The numbers were
not used to split commissions, but rather to facilitate the Brokers’ ability to
trade after their other broker identifying numbers had been blocked from
trading. PSI also provided the Brokers with “Also” numbers. The purported
purpose of “Also” numbers was to allow the Brokers’ customers to access only
those portions of a given broker’s portfolio that belonged to that customer or
to provide certain customers with commission discounts. The Brokers, however,
used Also numbers improperly in the same manner as they used FA and Joint
Numbers – to circumvent blocks that had been imposed on their other FA numbers.
Indeed, at least one mutual fund became so frustrated by its inability to
identify the Brokers that it threatened to curtail the trading privileges of all
brokers within a PSI branch to remedy the conduct.

 

  23. Each of the Brokers maintained numerous FA, Joint, and Also numbers, and
used these numbers interchangeably to execute trades for their customers. For
example, the Boston Brokers used 13 broker identifying numbers to place market
timing trades and the Garden City Broker used 49 broker identifying numbers.
When one of the Broker’s FA, Joint, or Also numbers was blocked from trading by
a particular mutual fund, he used another number assigned to him to place the
trade in that fund. Although each joint number ostensibly represented a unique
commission split, in fact each team of Brokers split commissions from mutual
fund purchases according to a single ratio, irrespective of which broker
identifying number was used to enter the trade.

 

  24. PSI failed to prevent the Brokers from opening hundreds of customer
account numbers. The Brokers’ customers maintained multiple accounts with PSI,
many of which bore fictitious names that had no relation to the actual
customer’s name. The Brokers used these customer accounts interchangeably to
execute trades. When one customer account was blocked from trading by a
particular mutual fund, the Brokers substituted another account for that same
customer to place the trade for that customer, thereby creating the appearance
that the trade originated from another customer.

 

  25. PSI failed to prevent the Brokers from obtaining accounts for their
customers that were coded as “Confidential.” Confidential accounts did not
identify the beneficial owner of the account on the transaction data provided to
the mutual funds. Although such a designation could have a legitimate purpose,
here the Brokers used Confidential accounts improperly to impede the mutual
funds’ ability to identify which PSI broker or customer was market timing their
funds.

 

  26. PSI also failed to prevent the Brokers from obtaining customer account
numbers with multiple branch identifiers. Typically, brokers located in one PSI
branch office had customer accounts that had a prefix used to identify the
branch location. Here, the Brokers established accounts for their hedge fund
customers using multiple branch codes, which effectively impeded the mutual
funds’ ability to identify the particular PSI office location, as well as
broker, that was market timing their funds. The Brokers used branch identifiers
improperly as another mechanism to conceal their identities and the identities
of their customers to mutual funds.

 

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PSI Received Notifications of the Brokers’ Deceptions

 

  27. During the Relevant Period, mutual fund companies sent more than a
thousand letters and emails to PSI concerning market timing by the Brokers. Many
of these communications asked PSI to take steps to stop further trading by a
particular customer account or FA number. Others expressly notified PSI that the
Brokers used deceptive trading practices to continue placing market timing
trades.

 

  28. High level officers of PSI were aware during the Relevant Period that
mutual funds were accusing the Brokers of using deceptive practices to evade the
mutual funds’ attempts to block the Brokers’ market timing trades. For example,
an individual who joined PSI in 1997 and rose to become the chief administrator
of PSI’s Private Client Group (“PCG”) in January 1999, then to become executive
director of PCG in November 2000, and finally to president of PCG in December
2002 (“the Senior Officer”) received repeated notices of wrongdoing by the
brokers throughout the Relevant Period, but did not take adequate steps to stop
the Brokers’ fraud. Among other things, the Senior Officer received the
following indications that the Brokers were committing fraud. In some cases,
certain other senior managers or high level officers of PSI also received
notices that the Brokers were committing fraud.

 

  29. On November 21, 1999, a senior executive in the PSI Mutual Fund Operations
division forwarded to the Senior Officer a string of emails concerning a
complaint from a mutual fund complex that the Garden City Broker had evaded a
block on two of his accounts by simply opening new accounts. Among other things,
the email stated:

It appears that [the Garden City Broker] circumvented this restriction by
requesting new BIN [account] #s and fund accounts be established, funded by
transferring shares into these new accounts on 11/8/99. Subsequently on
11/10/99, an exchange out of the money fund into our stock funds was processed,
beginning market timing again.

The cover email commented, “[T]his seems to be a serious matter that will only
get worse.”

 

  30. On January 19, 2000, the manager of PSI’s Mutual Fund Operations division
forwarded to the Senior Officer an email from another mutual fund complex
complaining that a member of the Boston Brokers had evaded a trading restriction
by opening a new account, stating:

It appears that [the member] set up another account in December for the same
client we restricted on 11/22.

 

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  31. On March 30, 2001, the head of PCG risk management sent to the Senior
Officer an email that attached a letter from another mutual fund complex
complaining that “excessive trading activity” by PSI brokers in its mutual funds
“has become detrimental to both the funds and shareholders of the funds
involved.” The letter described the tactics used by PSI brokers to avoid having
their trades canceled as follows:

Since trade cancellation began on February 26th, 2001, we have noticed several
types of reactions by Prudential Financial Advisors in order to circumvent our
attempts to terminate excessive trading. Originally, your Financial Advisors
established new identification numbers so that they would not be recognized as a
repeat offender. Secondly, Financial Advisors would transfer a fund(s) position
from account to account, in order to disguise their identity. Lastly, your
Financial Advisors have attempted to reduce the dollar amount of the exchange
orders while simultaneously increasing the number of exchanges (in the same fund
and account) in the hopes of not being identified.

 

  32. On June 28, 2001, the Senior Officer received an email from the manager of
the Special Accounts branch warning him that the Special Accounts Brokers were
obtaining multiple FA numbers in order to conduct their market timing, stating
that:

We will have an issue soon with joint FA numbers: in order to get around the MF
[mutual fund] timing issue they are starting to request 99/01 split numbers with
their junior partners to help them get around being shut down by some MF
companies on timing.

 

  33. On April 4, 2002, the manager of PSI’s Mutual Funds Operations division
sent an email to other senior managers forwarding an email from another mutual
fund complex complaining that certain PSI brokers were using multiple accounts
and FA numbers to evade restrictions on their market timing. The email stated:

What we have seen scares us. It appears certain representatives are changing
account registrations, tax id numbers, and branch and rep numbers in an effort
to time the [mutual fund complex’s] funds. All of these accounts have been
stopped, but each day “new” ones pop up.

When the PSI chief compliance officer saw the above email, he showed it to the
Senior Officer. The head of PCG risk management also discussed the email with
the Senior Officer.

 

  34. On April 29, 2002, the Senior Officer met with an internal PSI working
group that had been analyzing market timing issues. The group described for the
Senior Officer the mutual fund companies’ restrictions on excessive trading, the
fund companies’ block letters to PSI, and the deceptive trading strategies used
by certain PSI brokers, including multiple accounts and FA numbers.

 

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  35. On at least two occasions in May 2002, an employee of PSI’s risk
management division detailed for the Senior Officer several deceptive practices
used by the Garden City Broker. The employee’s analysis noted that in one 37-day
period, the Garden City Broker had 19 different mutual fund companies request
that accounts under the broker’s control, or the broker as an FA, be blocked
from their funds. The analysis concluded that the Garden City Broker had
circumvented these requests by changing his FA number to an Also or Joint Number
to avoid detection by the fund, or by changing customer account numbers and
moving the assets from the blocked account to a newly established account.

 

  36. On February 5, 2003, the director of strategic planning at PCG sent the
Senior Officer (then the President and most senior officer of PCG) a string of
emails from another mutual fund complex complaining that certain PSI brokers
were using multiple customer accounts and FA numbers for market timing. One of
the emails stated:

I have spoken to these reps a few times over the past several months about
stopping their timing activity to no avail. Over the past several months, we
have placed stops on 325 of their accounts as of 11/30/02 and continue to add
accounts daily. We see new accounts/rep id combinations being opened and have
determined that we are not able to continue chasing them within our funds. We
feel our only course of action to protect our fund shareholders is to prohibit
the attached list of reps from doing business with [our funds].

Another email in the string stated:

These reps have multiple rep ids and have continued to add new ones as we block
the ids within the NSCC trading system for our fund complex… These reps created
close to $3 billion in exchanges last year with $75 million of assets during a
time in which we placed stops on 350 of their accounts.

The director of strategic planning added his own warning to the Senior Officer:

I just wanted to give you a heads up on an issue that is sure to reach your desk
in the next day or two. As you can see from the attached string of notes, the
senior leadership team at [a mutual fund complex] are completely frustrated with
some of the tactics/strategies of FA’s [the Garden City Broker and the Boston
Brokers]. Previous attempts to curtail timing activity in the [mutual fund
complex’s] funds by blocking account activity have been thwarted by the
establishment of additional FA numbers. It appears that [the mutual fund
complex] is now making overtures that continued activity of this nature will
threaten the relationship between Prudential and the fund company.

 

  37.

On February 11, 2003, a PCG risk officer sent an email to the Senior Officer
(then the President and most senior officer of PCG) that forwarded an email from
the Garden City branch manager about the Garden City Broker’s market timing
business. The branch manager questioned the effectiveness of the Mutual Fund
Operations

 

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division’s internal blocking system and raised several other concerns about the
Garden City Broker’s activities:

Blocking of individual accounts by fund companies is extremely short-sighted in
consideration of the fact that each “entity” maintains multiple accounts with
our Firm.

There have been repeat offenses, at least in spirit…

Fund companies have been mislead as to the identity of the FA’s of record…
Recently, [a mutual find company ] was provided with information which was at
best misleading to effect the removal [of] a block.

[T]here is frequent journaling of funds between accounts.

At the present time, [the Garden City Broker and an assistant] either have or
have had a total of 48 FA #’s including single, joint and also numbers.

PSI’s Procedures to Limit Market Timing Were Ineffective

 

  38. Although PSI senior officers issued policies and procedures ostensibly
designed to proscribe the Brokers’ conduct, these policies and procedures were
ineffective in scope and were never fully enforced. Moreover, even in situations
where these policies and procedures purportedly were enforced, PSI senior
officers undermined them by granting exceptions for its largest producing
brokers. As a result, the Brokers’ deceptions continued even after these
policies and procedures were promulgated.

PSI’s June 2002 Procedure Concerning Issuance of FA Numbers

 

  39. In June 2002, PSI instituted a procedure concerning the issuance of FA
numbers, in a purported effort to hinder the Brokers’ ability to obtain “Joint”
numbers and “Also” numbers to evade limitations on market timing (the “June 2002
Procedure”). The June 2002 Procedure provided, simply, that requests for “Joint”
and “Also” numbers would require a documented business request and a PSI
Regional Business Manager’s approval. The June 2002 Procedure failed to preclude
the Brokers from misusing previously issued Joint and Also numbers to evade
blocks imposed by mutual fund companies. Indeed, the Garden City Broker obtained
12 new Joint and Also numbers just days before the procedure took effect,
purportedly to assist him in transferring customer accounts from one PSI branch
office to another. The June 2002 Procedure also did not subject the Brokers to
any form of discipline or sanction if they continued to use Joint and Also
numbers to evade blocks in violation of its terms.

 

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PSI’s January 2003 Market Timing Policy

 

  40. After protracted discussion involving PSI senior officers and attorneys
during the Fall of 2002, PSI issued a market timing policy on January 8, 2003
(the “Market Timing Policy”). PSI considered, and rejected, defining market
timing in the Market Timing Policy as a certain number of trades because of
concerns that doing so would have too great an impact the Brokers’ revenues. PSI
also rejected an absolute prohibition on the business of market timing. Instead,
the Market Timing Policy provided that “inappropriate timing activities [would]
continue to be monitored” by mutual fund companies and not by PSI itself.

 

  41. Unlike other PSI policies concerning market timing, the Market Timing
Policy expressly provided for the imposition of sanctions, including termination
of employment, for the brokers’ use of “manipulative techniques” to evade mutual
fund trading restrictions. Any imposition of sanctions was to be decided by a
committee consisting of members of PSI’s Legal, Compliance, and Risk Management
divisions. Despite notifications of continuing deceptive practices received by
PSI after it issued the Market Timing policy, PSI did not form this committee
and failed to take action against any of the Brokers to stop their use of
“manipulative techniques” to market time.

 

  42. The Market Timing Policy also provided that, in the event a mutual fund
company asked PSI to block any one of a broker’s FA numbers, all numbers
belonging to the broker similarly would be blocked from trading. However, PSI
senior officers determined not to implement this critical aspect of the Market
Timing Policy. In fact, despite the policy’s clear language, PSI interpreted
mutual fund block requests after it issued the Market Timing Policy in the same
manner as it had previously – as narrowly as possible, blocking only the
specific FA number or customer account number identified by mutual fund block
requests. Thus, even after issuance of the Market Timing Policy, the Brokers
were able to continue their fraudulent scheme of switching to unblocked FA
numbers or customer accounts to evade blocks imposed by mutual fund companies.

PSI Profited From the Brokers’ Deceptive Acts

 

  43. PSI identified the Brokers as early as 2000 and monitored their revenues
and ranks within the Firm throughout the Relevant Period. The Firm’s Mutual
Funds Operations division, which processed the Brokers’ trades in mutual funds,
monitored the Brokers’ activity because their rapid trading required the
dedication of additional staff within the department to process the trades and
strained the Firm’s trade processing and settlement systems.

 

  44.

In 2000, PSI began to track each quarter the gross commission revenues generated
by the Brokers. PSI prepared these reports to determine the amount of income
that would possibly be reduced if the Firm determined to eliminate market timing
as a business. In 2001, for example, the Brokers generated more than $16 million
in gross

 

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commission revenues for the Firm, most of which would have been eliminated had
the Firm phased out market timing at that time. Similarly, the Brokers generated
approximately $23 million in gross commission revenues for 2002, and received
another $10 million in gross commission revenues during the first half of 2003.

 

  45. As PSI senior officers became increasingly aware of the Brokers’ use of
deceptions, the Firm elected to continue the business of market timing. Indeed,
some of the Firm’s senior officers were aware that the June 2002 Procedure
concerning the issuance of multiple FA numbers and the January 2003 Market
Timing Policy were wholly ineffective at eradicating the Brokers’ deceptions and
that the Brokers and their hedge fund customers continued this activity. During
the Relevant Period, the Brokers generated approximately $50 million in gross
revenues as a result of this conduct.

DECISION

The Hearing Officer, in accepting the Stipulation of Facts and Consent to
Penalty, found Respondent guilty as set forth above.

PENALTY

In view of the above findings, the Hearing Officer imposed the penalty consented
to by Respondent of a censure, the payment of disgorgement in the amount of $270
million,3 and compliance with the following undertakings:

Independent Distribution Consultant. Respondent shall retain, within 60 days of
this Decision’s becoming final, the services of an independent distribution
consultant (the “Independent Distribution Consultant”) acceptable to
Enforcement.

 

  a. Respondent shall be responsible for all costs and expenses associated with
the development and implementation of a distribution plan (the “Distribution
Plan”). Such costs and expenses shall include, without limitation (i) the
compensation of a tax administrator for the preparation of tax returns and/or
for seeking any IRS rulings; (ii) the payment of taxes; and (iii) the payment of
any distribution or consulting services as may be reasonably required by the
Independent Distribution Consultant. Respondent shall cooperate with the tax
administrator to see that all tax payments are timely made, and all such tax
payments shall be deposited in the Qualified Settlement Fund upon notice from
the tax administrator concerning the amount and the deadline for payment.

 

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3 Payment of this amount, pursuant to an order issued in a related Commission
proceeding involving Respondent and the same underlying facts (the “Commission’s
Order”), shall be deemed payment in satisfaction of the Hearing Board decision
in this matter (the “Decision”). The terms of the payment and the distribution
of the disgorgement amounts are set forth in the Commission’s Order.

 

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  b. Respondent shall cooperate fully with the Independent Distribution
Consultant to provide all information requested for its review, including
providing access to its files, books, records, and personnel.

 

  c. The Independent Distribution Consultant shall develop a proposed
Distribution Plan for the distribution of the total disgorgement ordered in this
decision, and any interest or earnings thereon, according to a methodology
developed in consultation with and acceptable to the staff of the Commission.

 

  d. The Independent Distribution Consultant shall submit to Respondent and
Enforcement the proposed Distribution Plan no more than 180 days after this
Decision becomes final.

 

  e. The proposed Distribution Plan developed by the Independent Distribution
Consultant shall be binding, unless, within 210 days after the Decision in this
matter becomes final, Respondent or Enforcement advises, in writing, the
Independent Distribution Consultant of any determination or calculation from the
Distribution Plan considered to be inappropriate and states in writing the
reasons for considering such a determination or calculation inappropriate.

 

  f. With respect to any calculation with which Respondent or Enforcement do not
agree, such parties shall attempt in good faith to reach an agreement within 240
days of this Decision’s becoming final. In the event the Respondent and
Enforcement are unable to agree on an alternative determination or calculation,
the determinations of the Independent Distribution Consultant shall be included
in the proposed Distribution Plan.

 

  g. Within 285 days of this Decision’s becoming final, the Independent
Distribution Consultant shall submit the proposed Distribution Plan for the
administration and distribution of disgorgement funds pursuant to the Securities
and Exchange Commission’s Rules on Fair Fund and Disgorgement Plans, 17 C.F.R.
Section 201.1100, et seq., (Rules 1100 through 1106). Following a Commission
order approving a final plan of distribution, as provided in Rule 1104 [17
C.F.R. Section 201.1104] of the SEC’s Rules on Fair Fund and Disgorgement Plans,
the Independent Distribution Consultant shall take all necessary and appropriate
steps to administer the final plan for distribution of disgorgement funds in
accordance with the terms of the approved Distribution Plan.

 

  h.

For the period of the engagement and for a period of two years from completion
of the engagement, the Independent Distribution Consultant shall not enter into
any employment, consultant, attorney-client, auditing, or other professional
relationship with Respondent, or any of its present or former affiliates,
directors, officers, employees, or agents acting in their capacity as such. Any
firm with which the Independent Distribution Consultant is affiliated in
performance of his or her duties under the this Decision, or of which he or she
is a member, and any person engaged to assist the Independent Distribution
Consultant in the performance of his or her duties under this Decision, shall
not, without prior written consent of Enforcement,

 

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enter into any employment, consultant, attorney-client, auditing or other
professional relationship with Respondent, or any of Respondent’s present of
former affiliates, directors, officers, employees, or agents acting in the
capacity as such for the period of the engagement and for a period of two years
after the engagement.

 

  i. For good cause shown, Enforcement may alter any of the procedural deadlines
set forth above.

 

For the Hearing Board

/s/ Peggy Kuo

Peggy Kuo - Chief Hearing Officer

 

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