Exhibit 10.3


 


BEFORE THE SECURITIES COMMISSIONER


OF THE STATE OF KANSAS


 


	
  In the Matter of:

  	
   

  	
   

  
	
   

  	
   

  	
   

  
	
  WADDELL & REED, INC.,

  	
   

  	
  Docket No. 2004E020

  
	
  WADDELL & REED INVESTMENT

  	
   

  	
  KSC Case No. 2004-4821

  
	
  MANAGEMENT COMPANY, AND

  	
   

  	
   

  
	
  WADDELL & REED SERVICES

  	
   

  	
   

  
	
  COMPANY,

  	
   

  	
   

  



 


Respondents.


	
   

  	
  /

  



(A proceeding pursuant to K.S.A. 17-1266a)


 


STIPULATION
FOR CONSENT ORDER


 


This proceeding follows an investigation conducted by the Office of the
Securities Commissioner of Kansas. As a result of this investigation, staff for
the Securities Commissioner allege as follows:


 


ALLEGATIONS
OF FACT


 


a. Respondents


 


1.               Respondent Waddell & Reed, Inc.
(W&R), CRD #866, has been registered as a broker-dealer under the Kansas
Securities Act since 1961. Its principal business address is 6300 Lamar Avenue,
Overland Park, KS  66202. It is the
principal underwriter and distributor for the Waddell & Reed Advisors family
of mutual funds, which includes the Waddell & Reed Advisors International
Growth Fund, Inc. (“International Growth Fund”). Respondent W&R is a
Kansas-based broker-dealer with 171 registered representatives who reside in
Kansas. The registered representatives operate out of offices in 40 different
cities throughout the state.


 

















 


2.               Respondent Waddell & Reed Investment
Management Company (“WRIMCO”), CRD #106343, has been registered with the United
States Securities and Exchange Commission since 1992. Pursuant to K.S.A.
17-1254(e), it has made notice filings as a federal covered adviser with the
Office of the Kansas Securities Commissioner since 2001. Its principal business
address is the same as respondent W&R. It is the investment adviser and
manager for the Advisors Funds, including the International Growth Fund.


 


3.               Respondent Waddell & Reed Services
Company (“WRSCO”) provides transfer agent and accounting services to the
Waddell & Reed mutual funds, including the International Growth Fund. Its
principal business address is the same as respondent W&R.


 


b. Background – Description of Market Timing
in General


 


4.               Mutual
funds are generally priced once a day after the close of the markets. The share
price is the net asset value or “NAV.” 
The NAV reflects the closing price of the securities that comprise the
fund’s portfolio, plus the value of any cash that the fund manager maintains
for the fund, less the fund’s liabilities, and it is stated on a per share
basis. A mutual fund may trade shares during the day but, unlike stock, the
price of a mutual fund does not change during the course of the day. Orders
placed prior to 4:00 p.m. EST are entered at that day’s NAV while orders placed
after 4:00 p.m. EST are given the next day’s NAV.


 


5.               Mutual fund market timing involves the
rapid trading of mutual fund shares. The rapid trading strategy may be employed
to take advantage of the inefficiencies in mutual fund pricing. For example,
the NAV of a mutual fund containing international stocks may reflect stale
prices because the NAV does not immediately take into account events impacting
the overseas markets. As a result, a timer can anticipate a short-term upswing
in an international fund because of market conditions that are not yet reflected
in the stale NAV of the fund, and


 


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the timer can purchase shares at the undervalued NAV. Then, when the
NAV moves upward to reflect the new market conditions, the timer can sell its
shares in the short term at a profit.


 


6.               Short-term trading may harm long-term
investors in a mutual fund. The short-term trading can disrupt the management
of the fund’s investment portfolio because the portfolio manager may be forced
to liquidate securities in order to redeem the shares of market timers. This
causes an increase in transactional costs and commissions, as well as the
realization of taxable gains or losses on the trades that were necessitated by
timer redemptions. In addition, the portfolio manager may have to buy stock as
it is going up in price or sell into a falling market in order to accommodate
the inflows and outflows of timer funds.


 


7.               To prevent the disruption to the fund,
fund managers may maintain large enough cash balances to accommodate timer
trades without having to buy or sell securities at inopportune times. However,
this strategy can reduce the overall performance of the fund by requiring the
fund managers to keep a significant percentage of the fund assets in cash and
depriving investors of the advantages of being fully invested in a rising
market.


 


8.               Market timing may dilute the value of a
mutual fund by allowing the timer to siphon short-term profits from a long-term
investment vehicle. For example, a timer may invest an amount equal to 10
percent of the fund in anticipation of a short-term upswing in the NAV. If the
NAV rises as anticipated, the timer can immediately redeem its shares and take
10 percent of the profits from the upswing. This leaves the long-term
shareholders with 10 percent less than the profits they would have otherwise
received from the rise in the NAV. In effect, the timer clipped 10 percent of
the profits from the long-term shareholders, even 


 


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though the fund manager may not have actually invested the timer’s
money in the securities which generated the profits because the timer funds
were left as cash balances.(1)


 


c. Market Timing at Waddell & Reed


 


9.               In a prospectus and Statement of
Additional Information for the International Growth Fund dated October 15,
2002, the company described the investment philosophy of the International
Growth Fund as follows:


 


•                  Who May Want to
Invest:  International Growth Fund is
designed for investors seeking long-term appreciation of capital by investing
primarily in securities issued by foreign companies.


 


•                  The primary goal
of International Growth Fund is long-term capital appreciation, with current
income as a secondary goal.


 


10.         Prior to October 2001, the Statement of
Additional Information for the International Growth Fund did not refer to
market timing. In October 2001, the Statement of Additional Information was
amended to say “[t]he Fund may limit activity deemed to be market timing by
restricting the amount of exchanges permitted by shareholders.”


 


11.         From 1995 through 2003, the respondents
allowed certain clients to engage in market timing in Advisors Funds,
particularly the International Growth Fund. Beginning in December 1998, respondents
W&R and WRSCO entered into written agreements with at least three investors
which allowed the investors to engage in short-term trading, subject to certain
limitations on the number, amount and frequency of trades, in return for a fee based
on a


 






(1)           In some
circumstances, market timing can benefit a fund.  For example, in the example provided in
paragraph 8, if the fund declined in
value by 10 percent after the timer’s investment, then the timer’s investment
would be accretive to the fund.  This is
because while the fund’s equity assets decreased in value, the timer’s
investment remained in cash and suffered no diminution in value (and likely
earned interest).  Thus, the timer pays
10 percent of the decline in the value of the fund (although its investment
remained the same or increased in value), and the long-term shareholders avoid
paying that portion of the loss paid by the timer.


 


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percentage of the investor’s assets under management. Between 1998 and
2003, approximately $3.6 million was paid by the three investors to WRSCO.


 


12.         As a registered broker-dealer, respondent
W&R processed the transactions on behalf of the market timers.


 


13.         The respondents entered into written
agreements with known market timers, subject to certain limitations on the
number, amount and frequency of trades, despite the respondents’ having
received notice that mutual fund timing could have a harmful effect on the
funds and their long-term investors. The timing agreements and their possible effects
on the funds were not disclosed to the long-term investors. In addition, the
conflicts of interest created by the timers’ payment of special fees were not
disclosed to the shareholders in the funds.


 


d. Respondents’ Efforts to Control Other
Market Timers


 


14.         Initially, WRIMCO personnel handled any
monitoring of timing in the Waddell & Reed funds. Beginning in late 2000 or
early 2001, however, WRSCO undertook most of the fund complex’s limited efforts
to monitor timing activity. Although WRSCO initially did not have any
systematic means to detect timing or frequent exchanges, WRSCO personnel
sometimes noticed unusual activity and followed up to determine whether the
accountholders were timing the funds. When timers were discovered, the timers
were usually asked to enter into written agreements that, among other things,
contained certain limitations on the number, amount and frequency of trades. At
that time, WRSCO and W&R defined “market timers” as shareholders who
frequently moved all, or substantially all of their investments between money
market funds and non-money market funds, and who typically executed a “round
trip” at least once a month.


 


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15.         Beginning in mid-2001, WRSCO personnel
systematically tracked known timer accounts with monthly, and later daily,
schedules reflecting timer assets, timing capacity in individual funds, and timing
capacity in the complex as a whole, and monthly schedules that counted each timer’s
round trips.


 


16.         WRIMCO, and later WRSCO, generally enforced
the round trip limits in the written timing agreements once the agreements were
executed. In some instances, however, the respondents failed to obtain written
agreements from known timers for extended periods. For example, in March 2000, the
respondents identified eleven market timer accounts that had not executed
timing agreements, and they allowed six of the accounts to time far in excess
of the 12 round trip limit until they finally obtained written timing agreements
from them in March 2002.


 


17.         In an effort to limit timing in the Waddell
& Reed funds, beginning at least as early as 2002, WRSCO regularly
monitored and policed market timing and frequent trading in the funds through
third-party platforms, and took steps to stop such trading when it was
identified, including barring shareholders from the funds. However, at the same
time it was policing market timing and frequent trading by certain accounts, WRSCO
allowed certain known market timers, including the fee paying timers, to time
the funds.


 


18.         In May 2003, in an effort to discourage
timing, the respondents sought and obtained approval from the board of
directors for all of the W&R complex international funds to assess a 2%
redemption fee for redemptions or exchanges within 30 days of purchase.


 


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Allegations of Law


 


1.               Respondents W&R and WRSCO engaged in
an act, practice or course of business which operated as a fraud or deceit upon
the long-term shareholders of Waddell & Reed mutual funds, in violation of
K.S.A. 17-1253(a).


 


2.               Respondent WRIMCO engaged in an act,
practice or course of business which operated as a fraud or deceit upon the long-term
shareholders of Waddell & Reed mutual funds, in violation of K.S.A.
17-1253(b).


 


3.               Respondent W&R engaged in dishonest
and unethical business practices, in violation of K.A.R. 81-3-1(i)(1) and
K.S.A. 17-1254(m)(7).


 


4.               Respondent WRIMCO engaged in unethical
business practices, in violation of K.A.R. 81-14-5(a) and K.S.A. 17-1253(b)(5).


 


The respondents, wishing to obtain a disposition of this matter without
formal litigation, have determined not to contest the issuance of the attached Consent
Order.


 


IT IS, THEREFORE, STIPULATED AND AGREED, by and between staff for the
Securities Commissioner of Kansas and respondents Waddell & Reed, Inc., Waddell
& Reed Investment Management Company, and Waddell & Reed Services
Company, that:


 


1.               The respondents
acknowledge that the Securities Commissioner for the State of Kansas has
jurisdiction over the respondents and the subject matter of this action.


 


2.               The respondents
waive their rights to any hearing to contest the allegations set forth above,
consent to the issuance of the attached Consent Order, and waive their
rights to seek judicial review of this proceeding.


 


3.               The respondents neither admit nor deny
the allegations of the Commissioner’s staff as set forth above. Any findings,
statements of fact, or other provisions of this Stipulation and the


 


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attached Consent Order are not binding on any other person or
entity in this or any other proceeding, or on the respondents in any other
proceeding to which the Commissioner is not a party.


 


4.               The respondents, jointly and severally,
agree to pay a fine of $2,000,000 to the Office of the Securities Commissioner
within 30 days after the effective date of the attached Consent Order. It is
the intention of the parties, but not binding upon the State, that such funds shall
be used for the education of consumers in matters concerning securities
regulation and investments.


 


5.               Staff for the
Commissioner recognize the following mitigating factors:


 


a.               The respondents
have cooperated fully with the staff in the course of its investigation and
this proceeding.


 


b.              In a related case
involving the same conduct alleged above, the respondents have agreed to pay a
total of $50,000,000 to the United States Securities and Exchange Commission. Those
funds will be utilized to pay restitution to harmed investors, including Kansas
investors.


 


c.               In their settlement
with the SEC, the respondents agreed to implement changes to their management
and supervisory structures to prevent similar violations in the future.


 


d.              In a related case
involving the same conduct alleged above, the respondents have agreed to reduce
fees by a total of $25,000,000 over a 5 year period pursuant to an agreement
with the Office of the New York Attorney General.


 


6.               Staff shall
recommend to the Commissioner that, for good cause shown, nothing in this Stipulation
for Consent Order or in the Consent Order should constitute grounds
for disqualifying the respondents from the use of the Uniform Limited Offering
Exemption,


 


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K.A.R. 81-5-6(a)(2), or any other exemption
with the same or substantially similar disqualifications (commonly known as “bad
boy” provisions), in any future securities transaction otherwise effected in
full compliance with applicable securities laws and regulations.


 


7.               This Stipulation
for Consent Order and Consent Order conclude the Investigation brought by the
Kansas Securities Commissioner and any action the Kansas Securities
Commissioner could commence against Waddell or any of its current affiliates,
or any of the current or former officers, directors, or employees of Waddell or
any of its current affiliates, or any Fund arising from or relating to the
subject matter of the Investigation; provided however, that nothing contained
in this Stipulation for Consent Order or Consent Order shall be construed to
cover claims of any type by any other state agency or any claims that may be
brought by the Kansas Securities Commissioner to enforce Waddell’s obligations
arising from or relating to the provisions contained in this Stipulation for
Consent Order or Consent Order. The Stipulation for Consent Order and Consent
Order shall not prejudice, waive or affect any claims, rights or remedies of
the Kansas Securities Commissioner with respect to any person, other than
Waddell or any of its current affiliates, or any of the current or former
officers, directors, or employees of Waddell or any of its current affiliates,
and the Funds, all of which claims, rights, and remedies are expressly
reserved.


 


8.               On June 10, 2005,
respondent Waddell & Reed, Inc. entered into a settlement with the Kansas
Insurance Department, Docket No. 3468-CO, as part of a “global settlement” with
the NASD and other states for alleged violations involving the exchanging of
variable annuities. In the settlement, Waddell & Reed, Inc. agreed to pay
the Kansas Insurance Department a civil monetary penalty of $145,291.70. The
Office of the Securities Commissioner was not a


 


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party to the settlement and did not consent
to its terms; however, the respondent entered into the settlement in good faith
with an agency of the State of Kansas, so the Office of the Securities
Commissioner agrees not to take enforcement action with respect to the
allegations contained in the settlement agreement.


 


9.               This Stipulation
for Consent Order and the Consent Order shall be effective and binding only
when they are signed by all parties and the SEC order is approved and issued by
the U.S. Securities and Exchange Commission (referred to herein as the “effective
date”). This Stipulation may be executed in one or more counterparts, each of
which shall be deemed an original but all of which together shall constitute
one instrument.


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APPROVED BY:


 


 


	
  /s/ Daniel C. Schulte

  	
   

  	
  7/10/06

  	
   

  
	
  Daniel C. Schulte

  	
   

  	
  Date

  
	
  Senior Vice President and General Counsel

  	
   

  	
   

  
	
  Waddell & Reed, Inc.

  	
   

  	
   

  
	
  Waddell & Reed Services Company,

  	
   

  	
   

  
	
  Waddell & Reed Investment Management Co.

  	
   

  	
   

  



 


	
  State of 

  	
  KANSAS

  	
  )

  
	
   

  	
  ) ss.

  
	
  County of

  	
  JOHNSON

  	
  )

  
				



 


This instrument was signed before me on this, the 10th day of July, 2006,
by Daniel C. Schulte as the Senior Vice President and General Counsel of Waddell
& Reed, Inc., Waddell & Reed Services Company, and Waddell & Reed
Investment Management Co.


 


 


	
   

  	
   

  	
  /s/ Vicki K.
  McCune

  	
   

  
	
  (seal)

  	
   

  	
  Notary Public

  
	
   

  
	
  My appointment expires: 

  	
  6/12/09

  	
   

  
						



 


 


 


APPROVED BY:


 


 


 


	
  /s/  Rick A. Fleming

  	
   

  	
  7/13/06

  	
   

  
	
  Rick A. Fleming, #17127

  	
   

  	
  Date

  
	
  General Counsel

  	
   

  	
   

  
	
  Office of the Securities Commissioner

  	
   

  	
   

  



 


 


 


	
  /s/  Gail E. Bright

  	
   

  	
  7/14/06

  	
   

  
	
  Gail E. Bright, #14572

  	
   

  	
  Date

  
	
  Associate General Counsel

  	
   

  	
   

  
	
  Office of the Securities Commissioner

  	
   

  	
   

  



 


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