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He is a self-styled financial curmudgeon who frequently uses his monthly letter to harpoon Wall Street's follies. But now bond guru William H. Gross, the chief investment officer of Pacific Investment Management Co. (PIMCO), is on the other end of the spear. On Feb. 17, Jersey Attorney General Peter C. Harvey charged PIMCO and three related companies with securities fraud for allowing hedge-fund manager Edward J. Stern's Canary Investment Management LLC to execute frequent trades in PIMCO funds.
Gross isn't named in the complaint. But the veteran manager, who lords over PIMCO's $370 billion in assets, is working hard at damage control. In a Feb. 19 letter on PIMCO's Web site, later reprinted in major newspapers, he declared his firm's innocence. "Open air and sunshine are the best disinfectants," Gross told BusinessWeek on Feb. 24. Still, PIMCO's relations with Canary raised questions that the response leaves unanswered.
At the heart of the state's case is a December, 2002, agreement, which Gross confirms, allowing Canary to make one "roundtrip" trade in PIMCO funds each month. Such trades -- equal-size purchases and sales in the same fund -- aren't illegal. But many funds try to limit their frequency because rapid trading can increase expenses and hurt performance for other shareholders.
The problem is that the PIMCO funds' prospectus says the company has the right to refuse investors who make more than six such trades per year. Gross says that rule applied to Canary as well, but no mention of such a limit is made in an e-mail from PIMCO to Canary that outlined their one-trade-per-month agreement. (A copy of the e-mail was attached to the New Jersey complaint.) Gross says the limit was understood by Canary but can offer no documentation. "The reality is they never exceeded the limits in the prospectus," he says. A Canary spokesman says that it abided by the terms of the agreement.
Also troubling is the fact that Gross didn't know of the relationship earlier, nor did he reveal it immediately after he found out. He tells BusinessWeek he learned of it from investigators in mid-September, several days after New York Attorney General Eliot Spitzer announced a $40 million settlement with Canary over questionable trading at other firms. But PIMCO's connections to Canary didn't become public until the recent New Jersey suit. Should Gross have alerted investors last fall? "We could have handled it better," he says. "We could have told our clients earlier." Such disclosure, adds New Jersey's Harvey, "is what self-policing is about."
Gross's investment record is unimpeachable, and most of his clients are expected to stand by him. Still, they deserve a fuller account of what happened, why, and when. By Christopher Palmeri