Bank of America Corp. and FleetBoston Financial Corp. agreed Monday to pay $675 million in fines and restitution in the biggest settlement yet in the scandal over mutual fund trading abuses.
Bank of America also agreed to measures that would force eight of 10 directors off the board of its mutual funds unit, Nations Funds, within a year. It was the first time board reforms were a condition of a settlement since the industry probes began last year.
The pact with the Securities and Exchange Commission and New York Atty. Gen. Eliot Spitzer resolves civil fraud charges that the banks let privileged investors engage in trading practices that hurt regular shareholders.
In exchange for allowing late trades or the rapid in-and-out buying known as market timing, the banks received big, longer-term investments that generated handsome fees, regulators said.
The agreement settles unrelated cases but was made jointly because BofA is buying FleetBoston. The firms neither admitted nor denied the allegations, but analysts said the deal cleared a major uncertainty surrounding the proposed $48-billion takeover.
By including action at the board level, Spitzer's office said Monday's agreement marked a new phase in its effort to clean up the mutual fund industry. Aides said Spitzer would continue pushing for fund governance reforms, just as he had insisted on fee reductions in settling other fund cases.
"You can expect to see more of this," said Juanita Scarlett, a spokeswoman for the attorney general. "It's a critical new direction for our approach to the mutual fund investigations."
The settlement is the fourth since state and federal regulators started probing the $7.5-trillion fund industry in September. Regulators are investigating the trading and sales practices of at least 20 fund companies.
Fund companies have agreed to pay $1.7 billion to date, eclipsing the value of last year's $1.4-billion settlement with Wall Street investment banks regarding tainted stock research.
Monday's deal provides for payments of $250 million in restitution and $125 million in penalties by Charlotte, N.C.-based BofA. Boston-based Fleet will pay $70 million in restitution and $70 million in penalties.
BofA also agreed to governance reforms including term limits and a mandatory retirement age for its fund board. The agreement will force the departure of eight trustees by May 2005, spokesman Robert Stickler said.
In a separate accord with Spitzer's office only, the banks agreed to cut the fees they charge investors by a total of $160 million over a five-year period. Recently, Spitzer and the SEC have clashed over mandating fee reductions.
The banks said Monday that they welcomed the accords.
"These agreements represent Bank of America's good-faith effort to resolve this matter and [are] in the best interests of our customers, associates and shareholders," said Kenneth D. Lewis, BofA's chief executive, in a statement.
"We have worked closely with regulatory authorities to determine the facts on market-timing activity and to discipline those responsible," said Chad Gifford, FleetBoston's chief executive. "Any activity which disadvantaged customers is offensive, even though limited to a small number of individuals."
Analysts said the size of Monday's settlement -- eclipsing a $600-million deal reached in December between Spitzer and Alliance Capital Management -- was consistent with a belief that BofA was one of the worst offenders to have surfaced so far.
In his Sept. 3 complaint against hedge fund Canary Capital Partners, which touched off the scandal, Spitzer claimed Bank of America went out of its way to accommodate late trading and market timing.
The bank installed special computer equipment in Canary's office that allowed it to buy and sell Nations Funds and hundreds of other funds at the 4 p.m. daily closing price until 6:30 p.m. Regulators liken this practice to betting on a horse race after it's over. In return, Canary agreed to leave millions of dollars in Bank of America's bond funds on a long-term basis, Spitzer alleged.
On Monday, Spitzer scolded BofA's directors for allowing Canary's market timing, saying they "clearly failed to protect the interest of investors."
In a separate case filed last month, FleetBoston was accused of allowing market timing by various traders in its Columbia fund lineup.
Timing, which exploits small pricing inefficiencies, isn't illegal. But most fund companies officially discourage it, saying it can siphon profits from long-term shareholders and drive up costs shared by all.
By contrast, late trading is clearly illegal. It involves after-hours fund trades processed at that day's price, rather than the next day's price. By buying or selling at a stale price, late traders can take advantage of after-hours news, such as a bombshell earnings announcement.
"A lot of firms allowed market-timing schemes, but few allowed the more egregious practice of late trading," said Craig Woker, an analyst at Morningstar Inc. "There is no gray area there."
Still, some analysts said the governance twist to the latest settlement may send a muddled message.
"These settlements look ad hoc, like they're making them up as they go along," said Roy Weitz, editor of FundAlarm.com in Tarzana. "It's a little unclear why this board is being forced out and others have not."