Davenport Hit with $738,455 in Penalties

By Jonathan Stempel

NEW YORK (Reuters) - The NASD levied $738,455 in penalties against Davenport & Co. on Tuesday in what it called the first case against a broker-dealer for allowing improper market timing in variable annuities.

The regulator said that from April 2002 to September 2003, Davenport helped two hedge funds to market time in sub-accounts of variable annuities, although the brokers knew the annuities were designed for long-term investors.

The NASD said Richmond, Virginia-based Davenport agreed to a censure, to pay a $450,000 fine and to reimburse $288,455 to the affected mutual funds. Davenport neither admitted nor denied the allegations. The company and its lawyers had no immediate comment.

"Deceptive market timing ... rises to a higher level of abuse when the firm not only knows that its clients intend to deceive the variable annuity companies, but is complicit in carrying out that deception," NASD Vice Chairman Mary Schapiro said in a statement.

Variable annuities carry insurance benefits and are often bought as retirement investments.

The NASD said the fine also reflects Davenport's failure to maintain reasonable supervision and procedures to prevent "late trading" of mutual funds. It said the firm from July 2002 to September 2003 processed "hundreds" of trades received between 4 p.m. and 4:30 p.m. but at that day's closing price.

The NASD said it is still investigating individual brokers and other entities in the market timing matter.

Market timing is quick, in-and-out-trading that hurts ordinary investors. Late trading, which is illegal, involves trading after-hours at stale prices.

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One case the NASD cited involved a hedge fund that timed sub-accounts of the Western Reserve Life "Freedom Access" annuity.

When Western Reserve Life complained about the "disruptive" timing, which it said involved "very large dollar amounts," Davenport restricted the fund's timing activity.

Miffed, an official at the fund ordered a Davenport broker to submit a new application using a new entity and tax identification number.

"Let's put (Western Reserve Life) on our hit list once we get the new investment partnership set up," the hedge fund said in an e-mail to Davenport brokers. "We would like to get back in there (smiley face icon)."

Davenport later bought another Western Reserve Life annuity on behalf of another hedge fund managed by the same client, without disclosing this timing history, the NASD said.

The NASD also said Davenport received at least 10 letters from insurance companies expressing concern about excessive trading. Despite these and other "red flags," the firm failed to respond, the NASD said.