Canary Capital agrees to pay $40 million

NEW YORK — A hedge fund gained unfair trading privileges at several big-name mutual fund companies in an illegal arrangement that law enforcement officials say is widespread and could be costing investors billions of dollars.

Canary Capital Partners LLC, a multimillion-dollar hedge fund, and its managers agreed to pay $30 million restitution for illegal profits generated from unlawful trading and a $10 million penalty, New York Attorney General Eliot Spitzer said Wednesday.

In exchange for big-money investments, Spitzer said, several mutual funds bent the rules applied to most investors and allowed Canary to make after-hours trades and short-term "in and out" deals. Canary arranged to make such trades with several leading mutual fund families — including Bank of America's Nations Funds, Banc One, Janus and Strong.

Spitzer said his investigation, begun earlier this year, would continue and it was "a near certainty" that other mutual and hedge funds would be named.

The probe has "opened up a window on some of the practices used by the mutual funds that are detrimental to mom and pop investors," he said.

Under the settlement's terms, Canary did not admit or deny wrongdoing, and its officers agreed to cooperate with the investigation of the mutual fund industry. A statement from the firm said it agreed to the settlement "to avoid protracted and complex litigation." Its manager, Edward J. Stern, agreed not to trade in mutual funds or manage any public investment funds for 10 years.

All four mutual fund companies named in Spitzer's complaint against Canary issued statements Wednesday saying they were cooperating with the investigation.

Meanwhile, Massachusetts regulators were looking into similar activity at Prudential Securities' Boston office, a source in Secretary of State William Galvin's office said Wednesday. Prudential spokesman Darrell Oliver said the company "had no information about any investigation."

Mutual fund companies state in their prospectuses that they discourage or prohibit "late trading" and short-term "market timing" by large investors. But Spitzer's investigators found evidence that mutual fund managers permitted certain companies to conduct such trades in exchange for payments and other inducements.

At a news conference, Spitzer displayed e-mails and documents in which the firms discussed the schemes. In an April 2 e-mail exchange over whether questionable trades should be allowed, a senior official at Janus wrote, "I have no interest in building a business around market timers, but at the same time I do not want to turn away $10-$20 million. How big is the . . . deal?"