Strong Capital Faces Precipice Criminal Charges Could Be Filed Against Founder for Fund Moves

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Strong Capital Faces Precipice Criminal Charges Could Be Filed Against Founder for Fund Moves

By Tom Lauricella and Christopher Oster, The Wall Street Journal

November 11, 2003

The fate of Strong Capital could be hanging in the balance.

The New York attorney general's office is giving serious consideration to filing criminal charges against Richard Strong, founder and chairman of Strong Capital Management, for allegedly personally profiting from improper trading in the mutual funds that his company runs, according to people familiar with the matter.

Separately, the Securities and Exchange Commission is weighing civil charges against Mr. Strong and his firm. The SEC could also seek a federal-court injunction against Mr. Strong if the agency concludes that Mr. Strong's latest actions violated a 1994 settlement reached with the SEC, according to people familiar with the matter.

The most severe charges could lead to Mr. Strong being barred from managing money for clients or from being affiliated with a firm in the mutual-fund business if the allegations are proved or if he agrees to a settlement under certain circumstances. But complicating matters is that Mr. Strong owns about 90% of Strong Capital Management, the firm he founded nearly two decades ago. Although Mr. Strong, 61 years old, hasn't managed mutual funds for several years, he has remained the firm's central decision maker and is actively involved in overseeing all the firm's money managers.

The potential end result is that Mr. Strong could be forced to sell his company, which manages $42 billion in assets, but has begun suffering investor withdrawals.

This has huge implications" for the firm, says Paul Huey-Burns, a former assistant director of the SEC's Enforcement Division and now an attorney at Dechert LLP in Washington, D.C.

Stanley Arkin, Mr. Strong's attorney, says that discussions with authorities are continuing and that "we are facing all the potential prospects and doing so in a constructive and very sensible manner." He added, however, that he believed Mr. Strong's actions didn't amount to offenses that would warrant criminal charges. A spokeswoman for Strong Capital Management declined to comment on the possible charges against the firm.

While it isn't unusual for regulators to file charges against the principal owners of Wall Street firms that could bar them from the securities industry, several former regulators and securities lawyers said they couldn't recall a similar instance that involved a company as large as Mr. Strong's. Strong Capital Management, based in Menomonee Falls, Wis., operates 66 mutual funds and has 1,300 employees.

Even among the individuals and firms already facing charges stemming from the current investigations into mutual-fund trading abuses, the situation involving Mr. Strong appears unique. "This is an extremely unusual situation," says Julie Allecta, an attorney at Paul Hastings Janofsky & Walker in San Francisco, "In a situation where a person's name is on the door, and they run the company and they are the majority owner, it is very difficult to separate the fortunes of the company" from the individual, she said.

Mr. Strong is alleged by investigators to have engaged in short-term trading of Strong Mutual Funds in violation of the funds' rules discouraging such trading. The trading spanned several years and the profits amounted to at least $600,000, they say. In statements released by the firm, Mr. Strong has admitted to conducting trades on behalf of himself, friends and family. However, he has claimed that the trading wasn't "disruptive" to those funds and has pledged to repay any investor losses caused by his trading.

Strong Capital Management was cited, but not charged by Mr. Spitzer in early September for allegedly allowing a hedge fund to market-time the firm's funds in exchange for putting money into a hedge fund run by Strong. The firm is also alleged to have provided details of portfolio holdings to the hedge fund that weren't available to most investors. Mr. Strong resigned as chairman of the board of Strong Funds in early November, but he still holds a seat on the board and has maintained his position as head of Strong Capital Management.

The current troubles for Strong come after an earlier run-in with regulators. In 1994, Strong Funds, without admitting or denying wrongdoing, made restitution of $444,300 to three of its funds and agreed to other penalties when it settled SEC charges that it improperly moved securities among accounts that it ran during a three-year period ended in 1990. In addition, the SEC said that from 1987 to 1989, Mr. Strong traded securities in his own account at the same time the firm was recommending those securities to clients.

As part of the deal, without admitting or denying wrongdoing, Mr. Strong agreed to a "cease and desist order" under which he pledged to not violate securities laws governing defrauding clients.

Federal securities laws bar individuals from acting as investment advisers to mutual funds if they have been convicted of felonies or misdemeanors related to securities violations or found civilly liable on charges related to securities violations. That also holds true for individuals who plead guilty as part of settlements overseen by the courts. Under the Investment Company Act of 1940, a company can be barred from the mutual-fund business if an affiliated person, especially one that controls a company, falls into the category of being barred from the business for securities violations. If on the other hand, Mr. Strong was to be charged in an administrative proceeding by the SEC, which is used in a large percentage of SEC cases, he wouldn't necessarily be barred from the mutual-fund business.

The SEC also has the power to allow firms to remain in the mutual-fund business even if they violate securities laws by granting what is known as an exemption to the laws. In 1986 the SEC allowed E.F. Hutton & Co. to continue overseeing $10 billion in mutual funds despite a guilty plea the previous year to federal fraud charges.

Mr. Spitzer's office, meanwhile, has grappled with pressing charges against the chief executive of a major company before. The New York attorney general wrestled over whether to charge Citigroup Inc. Chief Executive Sanford Weill for his company's involvement in misleading small investors with overly optimistic stock research. But while Mr. Weill's name is widely associated with Citigroup, he doesn't own the firm. Ultimately, Mr. Spitzer decided to not file charges against Mr. Weill.

If Mr. Strong is forced to sell his controlling stake in Strong Capital Management, investment bankers say the fallout from the fund-trading scandal could cut into the price he could get for the firm. The big risk for a buyer, the bankers say, is that in the wake of the scandal, investors continue to pull their money out of the Strong funds. Last month alone, investors withdrew a net $503 million from the company's stock bond and money-market funds, according to a Strong spokeswoman.

Already, three states that employ Strong to manage part or all of their so-called 529 college-savings plans are considering shifting assets away. Wisconsin, Nevada and Oregon, which together have about $1.2 billion invested in such tax-advantaged plans with Strong, are evaluating those plans to in the wake of the scandal. Last week, Oregon Treasurer Randall Edwards recommended firing Strong as manager of a plan with $134 million in assets.

One-way around such a problem is for a deal to include a clause saying the price would be based on the assets under management at some date in the future.