Attorneys suing mutual-fund companies and brokers for allegedly scheming to favor wealthy clients over ordinary investors said yesterday...

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BALTIMORE — Attorneys suing mutual-fund companies and brokers for allegedly scheming to favor wealthy clients over ordinary investors said yesterday the case should go forward, because the defendants engaged in a plot to line their pockets at the expense of “moms and pops.”

Defense attorneys said the plaintiffs lacked legal grounds to sue.

The arguments came on the second day of hearings in U.S. District Court in Baltimore on motions to dismiss numerous civil claims that pit investors nationwide against 18 families of funds, including Janus Capital Group, Putnam Investments, Strong Capital Management and Alliance Capital Holdings. More than 200 legal complaints have been filed.

Alan Schulman, an attorney representing the plaintiffs, laid out his case, saying “secret deals with selected traders” allowed defendants to jump in and out of markets quickly while skimming profits, raising fees and providing “the keys to the vault” of oblivious investors. It allegedly cost them billions.

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“We have a course of business that operated as a fraud on investors,” Schulman told the three judges hearing the cases.

Traders, brokers and fund defendants schemed in an “ingenious device used to siphon money from the pockets of the moms and pops,” Schulman said.

The investors claim fund managers allowed quick in-and-out investing known as market timing. Although market timing is not illegal, most funds bar it because it racks up expenses that hurt long-term shareholders.

After hours?

Plaintiffs also contend rich clients were allowed to book after-hours trades at prices already closed to most fund shareholders — a practice known as late trading, which is illegal.

The plaintiffs emphasize that ordinary investors were not informed of the market timing that more wealthy and financially savvy customers were engaging in.

Judges J. Frederick Motz, Catherine Blake and Andre Davis repeatedly expressed difficulty in understanding how there could be a fraudulent scheme when market timing is legal.

In response, Schulman said the scheme would not have worked if everyone had been allowed to participate. While market timing may be legal, he said, the defendants figured out a way to use the practice to enrich themselves at the expense of clients.

“This wasn’t a level playing field,” said Deborah Weintraub, another attorney for the plaintiffs. She said market timing was available only to “a certain select group of people,” and the scheme could work only with large amounts of money.

“I see that a little better,” Blake said, after hearing several lengthy explanations.

Left in the dark

Defense attorneys jumped on the legality of market timing to argue that the plaintiffs didn’t have grounds to sue. Jonathan Polkes, a defense attorney, said there wasn’t any evidence to show mutual-fund holders lost money because of market timing.

Although the judges appeared to have trouble understanding how market timing played a role in the alleged scheme, Motz focused on how the average investor was left in the dark about it.

When Polkes underscored the lawfulness of market timing, Davis questioned him about the legality of concealing market timing from a large number of fund holders. Polkes said it was a troublesome point, but that only a small number of broker dealers did that.

Other options

Lewis Liman, who also is representing defendants, argued to remove the late-trading claims, saying those cases should be handled by the Securities and Exchange Commission, which is better equipped to handle them.

The defense also pointed out that more than $2 billion already has been set aside to cover complaints through independent distribution consultants, who were appointed to allocate regulatory settlements reached among holders of the funds.

But Schulman cited the enormous sum as evidence of widespread wrongdoing, saying the defendants didn’t put up $2 billion “because they’re good guys.”

The judges also focused on damage caused by shareholder flight from the funds after the market-timing scandal came to light. Defense attorney Steward Aaron told them there was no link between flight and alleged misrepresentation.

“We’re dealing with rank speculation here,” he said.