OppenheimerFunds to Pay $35 Million to Settle SEC Charges for Misleading Statements During Financial Crisis

June 6, 2012

The SEC charged investment management company OppenheimerFunds Inc. and its sales and distribution arm with making misleading statements about two of its mutual funds in late 2008.

The SEC found that Oppenheimer used derivative instruments known as total return swaps (TRS contracts) to add substantial commercial mortgage-backed securities (CMBS) exposure in the Oppenheimer Champion Income Fund, a high-yield bond fund, and the Oppenheimer Core Bond Fund, an intermediate-term, investment-grade fund.

The Champion fund’s 2008 prospectus didn’t adequately disclose the fund’s practice of assuming substantial leverage in using derivative instruments, and when CMBS market declines triggered large cash liabilities on the TRS contracts in both funds and forced Oppenheimer to reduce CMBS exposure, Oppenheimer disseminated misleading statements about the funds’ losses and recovery prospects.  The contracts provided substantial exposure to commercial mortgages without the purchase of actual bonds, but also created significant leverage. Starting mid-September 2008, CMBS market declines drove down both funds’ NAVs, forcing Oppenheimer to raise cash for TRS contract payments by selling securities into an increasingly illiquid market. 

According to the SEC, the funds’ portfolio managers under instruction from senior management began executing a plan in mid-November to reduce CMBS exposure. Just as they began to do so, however, the CMBS market collapse accelerated, creating huge cash liabilities for the funds and driving NAVs lower.  Continued declines forced the funds to sell more securities to raise cash. This task became increasingly difficult for the Champion fund, and Oppenheimer made a $150 million cash infusion into the fund on November 21. Over the next two weeks, the funds continued to reduce CMBS exposure.

According to the SEC, Oppenheimer advanced several misleading messages when responding to questions during these events. Oppenheimer communicated to financial advisers (whose clients were invested in the funds) and fund shareholders directly that the funds had only suffered paper losses and their holdings and strategies remained intact. Oppenheimer stressed that absent actual defaults, the funds would continue collecting payments on the funds’ bonds as they waited for markets to recover. These communications were materially misleading because the funds were committed to substantially reducing their CMBS exposure, which dampened their prospects for recovering CMBS-induced losses. Moreover, the funds had been forced to sell significant portions of their bond holdings to raise cash for TRS contract payments, resulting in realized investment losses and lost future income from the bonds.

The SEC found the Champion fund’s 2008 prospectus materially misleading in describing the fund’s “main” investments in high-yield bonds without adequately disclosing the fund’s practice of assuming substantial leverage on top of those investments. While the prospectus disclosed that the fund “invested” in “swaps” and other derivatives “to try to enhance income or to try to manage investment risk,” it did not adequately disclose that the fund could use derivatives to such an extent that the fund’s total investment exposure could far exceed the value of its portfolio securities and, therefore, that its investment returns could depend primarily on the performance of bonds it did not own.

The SEC found that OppenheimerFunds violated Section 34(b) of the Investment Company Act of 1940, Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933, and Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder. The SEC found that OppenheimerFunds Distributor violated Sections 17(a)(2) and 17(a)(3) of the Securities Act.

Click http://www.sec.gov/litigation/admin/2012/33-9329.pdf to access the administrative order.


Enforcement Actions, Investment Advisers, Investment Companies