NEW YORK (CNNMoney.com) - After almost 3 years of negotiations with the Securities and Exchange Commission as well other state and federal regulators, Prudential may be close to settling the investigation into unethical trading of mutual funds at its financial advisory unit.

During its fourth quarter report, released late Wednesday, Prudential (down $0.31 to $75.33, Research) raised its litigation reserves for the quarter -- a move that shaved off $267 million, or 40 cents a share, from the company's fourth quarter earnings.

Net income for the second-largest U.S. life insurer climbed to $377 million, or 78 cents a share, up from $317 million, or 64 cents a share, a year earlier.

But on an operating basis, the company posted earnings of $524 million, or $1.06 a share. That fell below Wall Street consensus expectations of $1.22 a share, according to earnings tracker Thomson First Call.

Prudential chief executive Arthur Ryan, however, sees a bright light at the end of the tunnel.

Speaking at the company's earnings conference call with analysts, Ryan said the company decided to increase its reserves based on his estimate of what it will cost to address the "market timing" issue that's plagued the company for years.

"I don't think anyone would disagree that this is a different environment for mistakes that are made and what it takes to resolve them" he said. "We're looking forward to reaching a settlement with authorities that would put market timing behind us."

Company executives added that Prudential, the second-largest life insurer in the country, is in active negotiations with regulators and hopes to reach a resolution quickly.

The Securities and Exchange Commission, NASD and state regulators began probing the company in 2003 related to "market timing" trades that former Prudential brokers engaged in that allowed some of their clients to profit from after-hours trading in mutual funds.

The company sold most of the unit to Wachovia (Research) in 2003 but retains a 38 percent stake in the business. It's long been a challenging joint venture for the company due to a combination of both litigation uncertainties and integration costs.

But Ryan said the company was confident that with the integration completed in 2005 and with hopes that its legal concerns would soon be a thing of the past, the unit was poised for more growth this year and beyond.

Despite a lower-than-expected earnings report, analysts stood by the company, blaming the weakness on non-recurring factors.

"I don't expect the Wachovia (joint venture) to be a big headache going forward," said Rob Haines, insurance analyst at CreditSights. "It's not a cheap stock but it's still a good franchise with good growth prospects."

Analysts were particulary bullish about the company's strong international business -- an area that Ryan expects double-digit earnings growth from -- as well as Prudential's solid excess capital.

Haines said Wall Street will keep a close eye on what Prudential, which has about $3 billion in excess capital, chooses to do with the extra cash.

While Ryan indicated that the company plans to buy back about $2.5 billion in stock this year, Wall Street has long been waiting for Prudential to make some strategic acquisitions.

"If they can do acquisitions that are well priced, that would be a preferred use of the capital," said Suneet Kamath, senior research analyst at Sanford C. Bernstein.

Talk of M&A activity in the life insurance space has heated up in the past year, especially after rival MetLife (Research) bought Citigroup (Research)'s Travelers Life & Annuity business and Lincoln National acquired Jefferson-Pilot.

This week alone, Protective Life (Research) bought JPMorgan Chase (Research)'s insurance business while Berkshire Hathaway, the insurance and investment company controlled by billionaire Warren Buffett, agreed to buy privately-held Applied Underwriters.

With Prudential's strong capital chest, the company has long been touted on Wall Street as the hot buyer in the market.

The company is also considered a hot buy, from an investment point of view. The company's stock surged over 30 percent in 2005, making it one of the top performing insurance stocks last year. While analysts expect some slowdown in its trajectory, they still see upside in the stock.

"The stock did have a good run last year and some people will look to take profits," Kamath said. "But if you come back to fundamentals like earnings growth and (return on equity), both of thos stats are moving in the right direction and justify more upside to the stock."

Prudential expects to earn $5.40 to $5.60 in 2006 with a 13 percent ROE, up from 12.4 percent in 2005. Ryan said the company is targeting double digit annual growth in operating income and earnings in 2006 and beyond.

Kamath has a 12-month price target of $86 on the stock.

--------------------------------------------------------------------------

AIG settled with the NY Attorney General. Find out more on that story.