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A hedge fund agreed to pay $40 million Wednesday to settle charges brought by New York Attorney General Eliot Spitzer that it had illegally profited in the after-hours trading of mutual fund shares. In announcing the settlement, Spitzer said his office, in an ongoing investigation of the mutual fund industry, has gathered evidence of widespread illegal trading schemes that could cost mutual fund shareholders billions of dollars annually. The hedge fund, Canary Capital Partners, agreed to pay restitution of $30 million and a $10 million penalty to settle charges that it had illegally profited by being allowed to trade after hours at the 4 p.m. closing price of the shares of five mutual fund companies. “The full extent of this complicated fraud is not yet known,” Spitzer said in a written statement, “but one thing is clear: the mutual fund industry operates on a double standard; certain companies and individuals have been given the opportunity to manipulate the system; they make illegal after-hours trades and improperly exploit market swings in ways that harm ordinary long-term investors.” According to a complaint filed in state Supreme Court in Manhattan Wednesday, the five mutual fund companies, whose shares Canary traded in after hours, were Bank of America’s Nations Funds, Banc One, Janus Capital Corp., Strong Capital Management and Security Corp. Trust Co. Bank of America, Banc One and Strong Capital Management all said through spokespeople that their companies are fully cooperating with the investigation. Brad Maione, a spokesman for Spitzer, said the settlement is “not the end of the story, but just the beginning.” He added that Edward J. Stern, a principal and manager of Canary, is cooperating with the investigation. Stern signed the settlement agreement. In addition to pledging full cooperation, Grant Seeger, chief executive officer of Security Corp. Trust Co., said his company had done “nothing inappropriate,” and had processed all trades “in a cycle consistent with the normal course of business.” Also, he said, the company’s agreements with all its clients, including Canary, require them to make trades during normal business hours. Janus Capital Corp. could not be reached for comment. Late trading at the 4 p.m. closing price of mutual fund shares is prohibited by New York state’s Martin Act and federal Securities and Exchange Commission regulations, Spitzer stated. Also, he said, mutual funds state in their prospectuses that they discourage or prohibit late trading. However, he added, the probe has turned up evidence that fund managers allow favored individuals and companies to engage in improper trading for payments and other inducements. Spitzer also stated that his office would take measures to insure that any illegal profits are returned to investors, and that reforms are adopted to prevent after-hours trading at the close-of-business price.

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