Southwest Securities to Pay $10 Million to Settle SEC and NYSE Supervision Charges

Washington, D.C., Feb 8, 2005 — The Securities and Exchange Commission and the New York Stock Exchange today announced the institution and settlement of enforcement proceedings against Southwest Securities, Inc., a Dallas, Texas based broker-dealer and investment adviser, and three of its managers. According to the SEC and NYSE, Southwest and the managers failed reasonably to supervise brokers in Southwest’s downtown Dallas branch office who engaged in fraudulent mutual fund market timing schemes, late trading of mutual fund shares, or both.

The SEC also announced that it filed a civil action in U.S. district court in Dallas today, against two former Southwest brokers, for allegedly engaging in a fraudulent market timing scheme. In that action, the SEC seeks injunctions, disgorgement of illicit profits, and civil money penalties, based on allegations that the two brokers committed securities fraud.

In settlement of the SEC and NYSE actions, Southwest has agreed to pay a total of $10 million, consisting of $2 million in disgorgement and an $8 million civil money penalty, and to undertake a number of measures to prevent future misconduct. The managers have agreed to settlements that include payments of disgorgement and civil money penalties totaling $275,000, as well as 12-month suspensions from association with a broker-dealer or investment adviser in any supervisory capacity. As part of the settlement, the firm and the managers neither admitted nor denied the SEC and NYSE findings.

Harold F. Degenhardt, Director of the SEC’s Fort Worth Office, remarked, “The SEC and NYSE actions against Southwest and three of its managers underscore the responsibility of broker-dealers and their managers to respond swiftly and completely when confronted with indications of late trading and improper market timing by their employees and customers.” Spencer C. Barasch, Associate Director and head of enforcement at the SEC’s Fort Worth office, added, “The actions against Southwest, its managers, and the registered representatives demonstrate the continuing resolve of the SEC and the NYSE to protect mutual fund investors from improper trading practices.”

Susan Merrill, Chief of Enforcement, NYSE Regulation, said, “This action sends a strong message that member firms and their managers must diligently supervise their mutual fund trading business to prevent and detect market timing and late trading. They cannot ignore red flags that should alert them to their brokers’ improper conduct.”

“Market timing” refers to the practice of short term buying and selling of mutual fund shares in order to exploit inefficiencies in mutual fund pricing. Although market timing is not per se illegal, many mutual funds try to prevent it because it tends to harm long-term mutual fund shareholders. “Late trading” refers to the practice of placing orders to buy or sell mutual fund shares after market close at 4:00 ET, but at the net asset value (NAV), or price, determined at the market close. Late trading enables the trader to profit from knowledge of market moving events that occur after 4:00 ET, but are not reflected in that day’s fund share price. Late trading is illegal.

According to the SEC and the NYSE, the fraudulent market timing schemes sought to circumvent trading restrictions that mutual fund companies imposed on Southwest brokers and accounts, by concealing from mutual fund companies improper market timing activities of Southwest brokerage customers. The SEC and NYSE found and alleged that more than 30 fund companies, representing hundreds of individual mutual funds, detected market timing trades by Southwest customers, and attempted to prevent further market timing by barring future trades, either in particular accounts or by a particular Southwest broker or branch office. In response, according to the SEC and the NYSE, Southwest brokers used “masking activities,” such as multiple customer accounts, multiple broker identification numbers, and multiple branch office numbers, to disguise their customers’ market timing trades and trick the fund companies into accepting the trades. For example, according to the SEC and NYSE, brokers in Southwest’s downtown Dallas branch office executed trades for a single hedge fund adviser customer, using 21 accounts held by nine customer-affiliated entities, and using three broker identification numbers. According to the SEC and NYSE, the brokers used these masking tactics for the sole purpose of circumventing trading restrictions imposed by the fund companies.