(FORTUNE Magazine) – Back in 1997, the new headquarters of Pilgrim Baxter & Associates was like a raucous boomtown within the otherwise sedate Main Line suburb of Wayne, Pa. The firm tripled its office space because it had quintupled its business with the roaring success of its PBHG Growth fund. Manager Gary Pilgrim's bold "momentum" investing style captured not just assets but the very zeitgeist of the '90s bull market. Who cared what companies actually did? The question was, How fast would they grow? People ditched horse-and-buggy "value" investing for the rocket ride of momentum. They flooded PBHG's toll-free lines with 80,000 calls a month, looking to plunk their money into its funds. Reporters paraded in to interview Pilgrim. Staffers constantly broke out the bubbly to celebrate milestones: $5 billion in assets, $10 billion, $20 billion.

There's no danger of being struck by flying champagne corks today. You could shoot a cannonball through Pilgrim Baxter headquarters and hit only cleaned-out desks. It's so still you can almost feel the reverberations from last Nov. 20, when the SEC and New York attorney general Eliot Spitzer turned their cannons on Pilgrim and his partner, Harold Baxter. The two men are accused of defrauding their long-term investors by letting favored short-term investors hop in and out of the funds at will. These so-called market-timers took advantage of a lag between the daily changes in the actual market value of a fund's stocks and the fund's publicly reported value.

Pilgrim Baxter is just one of seven mutual funds regulators have sued, or settled with, over market-timing violations--and more will follow. Spitzer's chief mutual fund buster, assistant attorney general David Brown, predicted in a recent speech that another ten to 20 firms will be cited. We're not talking about a few bad apples here. The market-timing scandals represent the culmination of a 20-year drift during which mutual funds went from being safe harbors for small investors to shark-infested waters. Mutual funds' assets grew 20-fold, to $7 trillion, in that period, but it was the funds' owners, not customers, who got wealthy.

The hucksters who flocked to this business preferred slickly gathering assets to prudently managing them. They offered more kinds of funds than Baskin-Robbins does ice cream and relentlessly hustled their flavor of the month. They promoted hot fund managers as stars and advertised their funds much as Paramount does blockbuster movies.

The promise of riches was illusory to investors, who often jumped into sizzling funds just as their returns crested and declined. For proprietors, on the other hand, mutual funds were virtually ATM machines. You could get 40% profit margins while you ran them and real money when you sold them. In 1998 alone, mutual fund operators reaped a $20 billion windfall by selling out to insurers, banks, and others clamoring to get into the business. And the more wealth these operators accrued, the more mutual funds diverged from their original mission--building the little guy's wealth through strength in numbers.

Pilgrim Baxter isn't the biggest firm charged with market-timing, but it may be the starkest example of how the profit motive swamped fiduciary duty. Gary Pilgrim and Harold Baxter were the guys with their name on the door, not factotums at a giant like Putnam. Yet they allegedly threw the door wide open and welcomed in a shady new breed of trader. They shored up Pilgrim Baxter's eroding asset base--and thus the fees they earned--by allowing market-timers to bend the rules and reap profits. At the same time, PBHG's legitimate customers suffered losses. Investors who got into the firm's hottest funds as of year-end 1996 cumulatively lost $3 billion, according to the Bogle Financial Markets Research Center. Fully a quarter of that sum may have stemmed from market-timing activities, legal investigators estimate, for the timers' profits translated to other investors' losses. Meanwhile, Pilgrim and Baxter personally cleared an estimated $1 billion between them over the years from operating and selling the firm.

The attorney for Gary Pilgrim and Harold Baxter hasn't yet filed legal replies to the SEC and Spitzer suits. Both Pilgrim and Baxter declined to comment on the allegations. They also declined to comment on estimates of the market-timers' toll on customers and of their earnings from the firm.

"No firm has been a bigger beneficiary of the trends that propelled this industry," says Don Phillips, managing director of mutual fund tracker Morningstar. "Pilgrim Baxter caught wave after wave: momentum investing, investors chasing performance, instant mass distribution from Schwab OneSource. They got phenomenally lucky, but instead of being grateful, they kept pushing the envelope."

"Not Gary Pilgrim." That's the first thing everyone said when they heard the news. He was an Eagle Scout, a straight arrow; even his name sounded like something from an Ayn Rand novel. Pilgrim came from Oklahoma, actually. His personality was dry as a dust bowl, making him seem a natural for his position in investments at Philadelphia National Bank's trust department.

Yet it turned out that beneath that laconic surface lay the soul of a wildcatter. While colleagues put their institutional accounts into the usual blue chips, Pilgrim discovered and plunged into small-cap stocks that were growing fast--until they stopped doing so. His portfolio was either sizzling or fizzling. He told investors they could expect great long-term returns, but they'd better ignore both the dips and the spikes. He stayed on message, even when in January of 1993 he got his first-ever call from the Wall Street Journal, which had ranked tiny PBHG Growth as the top mutual fund of the prior quarter. "That's ridiculous," Pilgrim told the reporter. "That doesn't mean a thing."

But Pilgrim didn't need an ounce of self-promotion when he had Harold Baxter, one of those classic salesmen who, in the words of a Philadelphia money manager, "could sell refrigerators to Eskimos." The large, gabby native of Queens, N.Y., was selling the Philadelphia bank's trust service when he came across Gary Pilgrim and found what every salesman loves--a point of differentiation. Sure, you should mostly be in blue chippers, he told pension managers, but give Gary just a little slice of your assets and give yourself some upside. Live a little!

Baxter left the bank in 1982 to go independent with Pilgrim and two other trust colleagues. Then Pilgrim started to really hit his stride, refining his stock-picking abilities with a computer stock-screening system, called QRS, developed by an early partner, George Greig. If reciting Pilgrim's returns didn't win over prospective clients, Harold Baxter just golfed them into submission. His client outings to Pebble Beach weren't to be missed, and his wit was always on. Jackie Charnley, a Dana Point, Calif., consultant, shares her log of one Baxter call: "As usual, Harold had me laughing from the moment I picked up the phone." When she asked after Pilgrim, Baxter cracked, "Gary's as exciting as ever--like watching paint dry."

He wasn't just the Willy Loman of growth stocks, however; he also had a sense for the next wave and how to ride it. Just as in the early '80s he figured out that institutional investors were getting adventuresome enough for Gary Pilgrim's white-knuckled ride, in the early '90s he saw that average Americans were shedding their inhibitions about investing in mutual funds. It just so happened he had one.

PBHG Growth wasn't much back then--it had been started as a favor to an institutional client and possessed only $8 million of assets in 1992. But Baxter was ready to answer when opportunity knocked. Pilgrim was on one of his periodic tears when Money magazine (FORTUNE's sister publication) discovered him. It calculated that PBHG Growth was the nation's top-performing mutual fund from mid-1992 to mid-1993, with a 69% return. The spikes of an $8 million fund aren't all that meaningful, but this time Gary Pilgrim didn't snort, "Ridiculous." He gave an interview to Money, which ran a story lionizing "this little-known hotshot" in its August 1993 issue.

Pilgrim Baxter had recently switched PBHG Growth from a "load" fund, requiring up-front fees, to a more attractive no-load one. It had also just set up an 800 number. Before the Money story ran, it had received six calls. After the story appeared--with the phone number--3,000 calls a day poured in from people clamoring to put their money into PBHG. Baxter had applied precisely the right formula for building the modern-day mutual fund: Create a track record, create a star manager, create a media buzz, and welcome the pigeons--er, customers. By year-end, PBHG Growth had $120 million and had only just begun.

In 1994, Baxter the salesman geared up for his biggest sale yet. He called Norton Reamer, CEO of a company called United Asset Management, and started talks to sell Pilgrim Baxter. Boston-based UAM was an acquirer of, and a holding company for, asset-management firms. UAM would buy out the partners, retain their services, and split revenues with them, roughly fifty-fifty. All of its 41 "affiliates" then were old-school "value" managers for institutional accounts. Reamer liked the idea of getting a growth shop; Baxter liked the idea of getting cashed out. In 1995, UAM bought Pilgrim Baxter for $135 million.

The kid from Queens was rich. He had a big stone house in the Main Line suburb of Berwyn, where he installed a first-class wine cellar and, with his wife, Christine, entertained lavishly. He bused legions of buddies to the Army-Navy game. He drove a top-of-the-line Mercedes, joined the elite Pine Valley Country Club, and played golf galore.

Gary Pilgrim never mingled socially with Baxter--or with just about anyone else, as far as colleagues could tell. When Pilgrim wasn't in his office he disappeared into his home on an isolated road in the less fashionable suburb of Malvern. At a party UAM threw after acquiring Pilgrim Baxter, Norton Reamer made a little speech to assure the firm's employees that nothing would change. Then Pilgrim was pushed to his feet to say a few words. "Well, that's not really true, Mr. Reamer," he said, as later recounted in SmartMoney magazine. "One thing has already changed. You got Gary Pilgrim out on a Friday night."

As a matter of fact, a big change was in the works. Pilgrim Baxter was still mainly an institutional firm when the UAM deal closed in April 1995--PBHG Growth made up only a quarter of the firm's $4 billion of assets. But Pilgrim Baxter was about to morph into a very different, very retail beast.

Momentum investing, a niche in the 1980s, was the essence of the 1990s bull market. The old preoccupation with fundamentals and P/E ratios went the way of the ticker tape; young, high-tech companies were thought to have potential that overshadowed profits.

Mutual fund families gave birth to growth funds by the gross during the bubble. Just as casinos offer something for every gambler's taste--blackjack, slots, roulette--mutual funds offered something for every investor's fancy: micro cap, small cap, everything but baseball cap. And as with the gaming industry, the house won. Mutual funds typically took 1% off the top in management fees. Since their costs grew far less rapidly than their assets--which spurted 32% per annum in the 1990s--this was a business model you couldn't beat. Things weren't so great for mutual fund investors, whose returns typically lagged the market. The average fund delivered just 76% of the market's annual return from 1982 to 2002, according to the Bogle research center. Much of the discrepancy was due to costs--not just management fees but the funds' transactions charges and taxes.

The increasingly speculative nature of mutual funds was dispiriting to some who remembered a time when they were supposed to reduce risk by pooling small investors' money and spreading investments over many stocks. "There was a missionary zeal to it then," says Burt Greenwald, a Philadelphia mutual fund consultant who entered the business in 1958. "We were doing God's work for the modest investor. From 1980 on, there was a slow disintegration of that culture and an entry of people who realized it was a hot business."

Among the momentum funds, PBHG Growth was the hottest of the hot. Lipper, in January 1996, ranked it tops in returns not only for the first half of the 1990s but also for the prior decade. The October 1996 Kiplinger's investment newsletter declared: "Forget Peter Lynch: Gary Pilgrim is the best stock picker of the past five years and the past ten."

Harold Baxter had always been able to sense that next wave, but he never expected a tsunami. The mutual fund grew from $2 billion by the end of 1995 to $5 billion by mid-1996. He created new specialty funds--PBHG Emerging Growth (small cap), PBHG Limited (micro cap), PBHG Large Cap. As the money washed in, it quickly became clear that he had sold his firm too soon and too cheaply.

By mid-1996, Pilgrim Baxter was at $15 billion in total assets, with a bullet. People familiar with UAM's revenue-sharing formula estimate Baxter and Pilgrim were splitting $20 million a year. But in the latter half of the '90s, the serious money was made by selling mutual funds, not by operating them. Michael Price, for instance, sold his firm to Franklin Resources for $670 million. And Harold Baxter had sold out for a lousy $135 million. It was enough to make a man want to crawl into his wine cellar and never emerge.

Baxter became fixated on how much money he had left on the table, former associates say, and on how much he could yet make to set that right. That imperative manifested itself in any number of ways:

--THE HOARDING. UAM encouraged the principals of firms it acquired to share the wealth with nonpartners. Norton Reamer wanted sale proceeds to be spread around to keep key managers motivated. Harold Baxter wouldn't do that, but he promised the staff something else. After deducting UAM's share of revenues and firm expenses, he would put Pilgrim Baxter's annual take into two pots. A large majority would go into the "A" pool, to be divided by him and Pilgrim. The rest went to a "B" pool, to be divvied by the rest. Later, Baxter made another seeming act of largesse, giving fund managers bonuses to sign five-year contracts. They were delighted to do so and collect anywhere from $250,000 upwards. Only later did they learn Baxter had paid the bonuses out of that "B" pool--in other words, with their own money.

--THE DAUGHTERS. Baxter was genuinely devoted to his wife, Christine, and their four children. "I love my family more than you love the air you breathe," he once said to me. "The amount of golf I give up for them ..." That devotion extended to the Baxter family business, where he made one daughter, Patty, a $100,000-a-year office manager, and put another, Chrissie, in charge of the PBHG Emerging Growth fund, fresh from her graduation as a University of Pennsylvania philosophy major. After a strong first three years, when she averaged 42% returns (aided, as with the early PBHG Growth, by hefty IPO allocations), Chrissie faltered, wearied of mutual funds, and moved on to a PBHG private equities fund. She was succeeded by a young woman named Erin Piner, who didn't have CFA (Certified Financial Analyst) credentials but was Patty Baxter's best friend.

The Baxter girls had Dad wrapped around their fingers. Chrissie became friends with a trader named Margaret Mace, who chafed under head trader Scott Shellhammer. Mace decided to leave, but Chrissie wouldn't hear of it. She insisted that her friend become the trading-desk boss. Though Shellhammer was very good at his job and a Gary Pilgrim protege, he was gone.

--THE HEDGE FUND. The PBHG growth funds were a management challenge, yet on the side Harold Baxter was quietly developing another business. In 1995 he brought into the firm a California-based hedge fund, Palomar Capital Management, whose mastermind was a former Montgomery Securities partner named Ben Simon. Baxter delivered to Palomar some of its investors and most of its market edge. Simon was privy to the holdings of the PBHG funds and their trading plans, according to people then working at the firm. That was very good dope, since Gary Pilgrim had the clout to move stocks. Pilgrim and Baxter shared in Palomar's management fee--about 20% of the hedge fund's asset totals.

Through a spokesperson, Pilgrim and Baxter deny that they shared portfolio knowledge or earned management fees. Thomas Krouse, then Palomar's chief executive, says, "We utilized the same research group (as the PBHG funds) and sometimes traded in the same stocks on the same days. But explicit compliance features were in place to assure fairness." He declines to discuss fees but acknowledges that there were "financial incentives" for Pilgrim and Baxter.

People at the firm who had admired Pilgrim were increasingly vexed and perplexed. Pilgrim was not just an investing talent but a doer of good deeds--active in a Presbyterian church, sponsor of a Vietnamese family's U.S. immigration. He never seemed a grasper like his partner. (I once asked him, after PBHG Growth's $3 billion hemorrhage in 1997--98, if he felt bad about all the money lost. "That would assume," Pilgrim replied, "that money is important.") So colleagues hoped he would counterbalance Baxter's more dubious moves. Instead he seemed willfully oblivious to them. He was like the piano player at the bordello who didn't want to know what was going on upstairs; he just wanted to keep the music going and pocket the checks.

Like his partner, Pilgrim developed pricey tastes. Baxter bought a $4 million house on Nantucket; Pilgrim bought a $5.5 million house there. Baxter bought a $3.5 million place in Palm Beach; Pilgrim bought a $4.8 million place in Naples, Fla. Baxter bought a corporate jet; Pilgrim bought a share of one too. The poor boy from Oklahoma got as distant from his roots--and his customers--as the kid from Queens.

Every time Harold Baxter had a choice between building his net worth and building an institution, he opted for the former. The PBHG funds were far too dependent for business on the Schwab and Fidelity "supermarkets"--so called because people can one-stop-shop for a wide variety of funds. PBHG Growth owed much of its mid-'90s growth spurt to Schwab OneSource, but those assets were known as "hot money." Many people used supermarkets to get into the latest chart-topping funds. Once they cooled off, those fickle sorts moved on to another aisle.

Pilgrim Baxter would have had a stabler foundation had it sold funds through networks of stockbrokers or financial planners. Several times Baxter made tentative runs at doing so, only to conclude it would take too much trouble and money. In 1997 he even hired former Fidelity executive Paul Hondros, a marketing and distribution whiz. Hondros rapidly set about building up Pilgrim Baxter's business side, which had advanced woefully little from when marketing and distribution consisted of Harold Baxter regaling clients at the 19th hole. Three problems quickly developed. Baxter had made Hondros the firm's president, but he didn't really want to share power. Baxter found it was costly to hire "wholesalers" who mass-marketed funds and to make deals to enter stockbrokers' networks. The third problem was PBHG Growth. After its long, steep climb, the fund reached the top of the roller coaster--and careened down. In one 12-month stretch in 1997 and 1998, its assets plummeted 50%, to $3.1 billion.

Part of the reason was that momentum investing lost momentum. Investors looking for the next big killing became more enamored of big-cap stocks. But the fund's customers were also paying a steep price for its operators' greed. The momentum game requires agility, and PBHG Growth had become far too big to continue reaping large returns. With so much money, Gary Pilgrim couldn't get into or out of stocks as quickly as he once did.

Many firms close popular funds when they reach a point at which their size will diminish returns. Not Pilgrim Baxter. It did temporarily close PBHG Growth in 1995, at $5 billion in assets. But it reopened the fund in early 1996, just in time to take advantage of the No. 1 ranking by Lipper. At $6 billion, the fund bore no resemblance to the sloop in which Gary Pilgrim made his name. It was more like a destroyer--a wealth destroyer.

After the long run of grand years for Pilgrim Baxter, 1998 was a perfectly awful one. The bull market was interrupted that summer by the Russian currency crisis. The short but menacing entry of the bear was particularly hard on the firm. Investors' flight to quality did not take them in the direction of PBHG Growth. After declining 50% in the 12 months ended in August 1998, it fell another 23% in just one week in September. Then a tentative deal for the firm to be sold--and for Baxter to get the "liquidity event" he craved--fell apart. With Baxter's and UAM's blessing, Hondros had found an interested acquirer in Nationwide Insurance. The Columbus, Ohio, company offered $600 million for Pilgrim Baxter, but there was a sticking point: Harold Baxter wanted $100 million of that sum. Even though he and Pilgrim no longer owned the firm, that was the price he set for voiding their UAM revenue-sharing arrangement. In October 1998, amid the market carnage, Nationwide called off the engagement and walked away. A few days later Paul Hondros got his walking papers.

That's when, the suits say, the market-timing activities started gearing up. As PBHG's legitimate customers streamed out, Harold Baxter proved willing to let illegitimate ones in. He wanted to start looking for other buyers, and he had to shore up PBHG's assets by whatever means necessary. Having dispatched the one executive who could have challenged him, Hondros, and being challenged by no one on his board--the three outside directors had never been in mutual funds--Baxter could pretty much do as he pleased.

Baxter's best friend, Alan Lederfeind, ran a brokerage firm called Wall Street Discount Corp. He had a hedge-fund client called Canary Capital, whose general partner Edward Stern was intrigued with this growing phenomenon of market-timing. It involved using the pedestrian mutual funds of John Q. Public for a slick little arbitrage opportunity. The trick was in taking advantage of how the funds were priced. At the end of each market day the cumulative worth of a fund's stocks--expressed as "net asset value," or NAV--was adjusted and publicly posted. But those NAV listings were "stale"; they didn't necessarily have the most up-to-date prices on funds' holdings. If a fund had stocks listed on a foreign exchange, for instance, there could be a lag in its latest close's being reflected in the NAV. But the smart money knew what had happened on the Nikkei. Market-timers could profit from from the spread between a fund's posted NAV and where they knew the NAV was headed.

Harold Baxter met Eddie Stern at the Oak Room in the Plaza Hotel in Manhattan, according to investigators, and over dinner gave him carte blanche to market-time the PBHG funds. Pilgrim Baxter would essentially be the training wheels for the firm that became the most notorious mutual fund timer of all. Baxter asked, in return, that Canary put some "sticky assets," money that wasn't jerked in and out of PBHG, into his daughter Chrissie's private equities fund. Stern came across with $4 million for it, investigators say. Through a spokesperson, Baxter denies that he gave Stern a green light to market-time PBGH funds, and that his daughter's fund received the assets.

Oh, how that man doted on his daughters, but oh, how other PBHG fund managers hated those market-timers--"financial terrorists," one called them. The hyperactive traders forced managers to buy and sell stock when they didn't want to and to keep more cash on hand than they wished, to cover possible redemptions. Beyond that, market-timers' transaction costs and arbitrage profits came out of the pockets of the people PBHG was supposed to serve--the buy-and-hold investors. When it reached the point where PBHG funds were being swarmed by an estimated 100 market-timers, some managers complained bitterly to Gary Pilgrim.

He approved a new policy, limiting PBHG customers to four trades in and out of funds per year. There was one exception: Alan Lederfeind, whose Wall Street Discount clients, Canary and others, accounted for two-thirds of PBHG's market-timing activity. And those favored timers didn't just play the game; they also got big advantages. Investigators say they knew at all times what stocks were owned by the PBHG funds, information the funds had to disclose publicly only twice a year. It was a special relationship that, for the timers, was like shooting fish in a barrel.

Pilgrim would later nurture his own special relationship, with a hedge fund called Appalachian Trails L.P. It was run by a former institutional trader he'd befriended, Michael Christiani, and based on a dense mathematical model that involved shuttling money between equity funds and fixed-income funds. Pilgrim helped Christiani get started with a $1 million investment in 1995. Then he really helped him starting in 2000, by allowing Christiani to do his shuttle thing between PBHG Growth and PBHG Cash Reserves, a money-market fund. That year, according to the SEC suit, Pilgrim also increased his investment in Appalachian Trails to $28 million, or a 45% stake. In 2000 and 2001, Appalachian made $13 million from market-timing the PBHG funds (of which Pilgrim's share was $3.9 million), while the value of PBHG Growth was sharply declining.

What on earth were the motives here? Harold Baxter and Gary Pilgrim were rich beyond their wildest dreams. Yes, they rued the lost opportunities to make zillions off the mutual fund acquisition frenzy. Yes, they had lost billions in assets out of PBHG Growth. But they risked losing something far greater by casting their lot with market-timers: their reputations.

Even when the firm's fortunes spiked back up in 1999 and 2000--the crazed last days of the bubble, when small-cap momentum funds rode tall again--the partners couldn't just live off the cornucopia of fees that came when its assets levitated back north of $20 billion. Nope, they had to get the biggest piece of the action in PBHG's hottest fund. A new micro-cap fund, PBHG New Opportunities, soared 533% that year. Its three biggest shareholders were Mrs. Gary Pilgrim (11.6%), Harold and Christine Baxter (6.7%), and the PBHG 401(k) plan (5.2%). The partners' stake was buried in an SEC filing but open knowledge around the firm. So was knowledge of PBHG's usual trick for propelling performance: New Opportunities' outsized share of IPO allocations.

PBHG fund managers began streaming out of the place. That was partly because there were so many other opportunities and so few reasons for loyalty (see the "B" pool incident mentioned above). But it was also because some managers were creeped out by the corruption of the place. "I knew some of what was going on," says one who left, "and I was terrified by what I didn't know."

UAM executives were pretty terrified too. They maintain today that they never knew about the market-timing. But they did know that Pilgrim Baxter could all but evaporate if the bubble were to burst. UAM engaged Goldman Sachs to scour the world for a buyer. Goldman found one: a British financial services company called Old Mutual. Harold Baxter delivered perhaps his greatest sales job yet for Old Mutual's brass. He took PBHG's blowout performance in 1999 and projected from it the most robust growth imaginable. It was what Old Mutual wanted to hear. By then many other insurers had obtained a U.S. "retail platform," and Old Mutual had come to want one in the worst way.

So, in mid-2000, Old Mutual actually agreed to buy all of UAM for $2 billion. Then, to secure maximum value from the firm it really coveted, Old Mutual made a separate deal with Pilgrim Baxter. It wanted to end UAM's revenue-sharing arrangement with the firm, gaining access to every penny produced by the "crown jewel." In return they would pay Harold Baxter and Gary Pilgrim $400 million. Sold, said the partners.

Old Mutual got its U.S. retail platform in the worst way, all right. Pilgrim Baxter promptly went in the tank. The bear market mauled growth stocks particularly badly. When it did, Pilgrim Baxter was exposed for what it was--more a triumph of opportunism than a place of business. Its fortuitous success had arrested its institutional development. Burt Greenwald, the Philadelphia mutual funds veteran, was stunned when he did some consulting there for Old Mutual. "For an organization that was so successful in attracting assets, they had little, if any, business infrastructure," he says. "The place was being held together by glue and wire and paper clips."

Even more stark was the consequence of the firm's failure to build up its fund-management capabilities. Gary Pilgrim's QRS system, once his secret weapon, wasn't updated and had become less sophisticated than rivals' stock-screening systems. That is one reason why over the past three years PBHG Growth has fallen 28%, and its peers only 8%, according to Morningstar. Harold Baxter's nepotism hurt, too, particularly as the pros left. The 8% annual loss average of Erin Piner, the now-departed PBHG Emerging Growth manager and Patty Baxter's roommate, put her in the bottom 2% of such funds. Her fund had withered to $500,000 in assets from its $1.8 billion peak in 1997.

Can Pilgrim Baxter be put together again? David Bullock, the new CEO, is trying to signal a new day. He has adopted a tough code of ethics for employees, tightly restricting their ability to trade any stocks in their PBHG portfolios. He has drawn up no-exceptions anti-timing rules, including the imposition of steep redemption fees on frequent traders. "Without a doubt, our priority is taking care of our shareholders," he says. "The best way to respond to all this is to provide them quality investments and world-class service."

Funny how such cliches actually sound like radical manifestoes when uttered by the man who succeeded Harold Baxter. Baxter and Pilgrim resigned last November, just before the Spitzer and SEC suits. Life has not been good for them since, and not just because of their legal troubles. Baxter's wife died of cancer in December. Pilgrim is in a state of shock, according to people who have been in touch with him. He never believed he was hurting PBHG's investors. But that's what happens when you become so distant from your customers, and that's what mutual-fund firms everywhere had better learn from this sorry era. The money is the customer's, and the profit motive isn't all.