Thereafter, CIHI opened managed accounts at STC for both hedge fund customers,
who then market timed mutual funds and submitted trades after 4:00 p.m. EST. In doing so, the hedge funds enhanced their returns with the leverage provided by CIHI.
CIHI was well aware that mutual funds disliked the market timing they were
financing, and actively attempted to shut it down. For example, in an undated “confidential”
memo entitled “Market Timing Business,” CIHI officials wrote “[t]his business has a high level of
confidentiality since Mutual Fund Companies discourage the trading of their funds. Investment Advisors pay significant fees to broker/dealers due to the stealth nature of the business.” Then, arguing in favor of limited disclosure about its business, CIHI wrote, “[w]e believe our future success is directly related to keeping this information confidential given the stealth nature of the underlying investment strategy.”
Initially, CIHI generally opened its managed accounts for its customers at World
Markets. However, “once the business grew to a certain volume” CIHI began opening managed
accounts at other broker-dealers, because World Markets “could no longer ‘hide’ the market timing transactions in with normal business flow.” By opening managed accounts at other broker-dealers,
CIHI’s financing customers could evade mutual funds’ efforts to block market timing coming through World Markets.
CIHI Created Subsidiaries Without the “Canadian Imperial” Name to Hide Market Timing
Over time, even the fact that CIHI had opened managed accounts at other broker-
dealers did not prevent the “Canadian Imperial” name from becoming known to mutual funds as a notorious market timer. This was because the managed accounts at other broker-dealers were in CIHI’s name. Consequently, CIHI began looking for ways to keep the “Canadian Imperial” name off the managed accounts. It did so by creating new subsidiaries, without the “Canadian Imperial” name, to book the purported TRSs (meaning the subsidiary’s name, not CIHI, would be on the managed accounts). CIHI also created hedge funds that CIHI wholly-owned and financed but which lacked the “Canadian Imperial” name and which then entered into purported
TRS transactions with CIHI’s market timing finance customers.
More specifically, in September 2002, CIHI officials proposed creating new
subsidiaries in which to book their mutual fund timing TRSs. As a CIHI business manager explained, the new entities would be used to book the mutual fund swap business and were
needed because, “we’re at a point where we need to book purchases of assets (mutual funds and
annuities) in multiple vehicles in order to reduce CIHI’s ownership perception to the ‘street.’”
A number of senior officials who reviewed this proposal raised questions
“whether we are violating any securities laws or regulations and/or running some reputational or customer-relation risk.” One even questioned “[w]hy do we want to do this in the first place? What does it mean to ‘reduce CIHI’s ownership perception to the ‘street’? Are we trying to skirt
some law here?”