SEC Fines Fund Adviser for Overvaluing its Securities and Misleading Performance Disclosures

May 4, 2020

On April 28, 2020, the SEC fined a fund’s adviser in a consent order (Order) for the adviser’s conduct involving the fund’s overvaluation of its securities and the adviser’s misleading statements about the fund’s performance in shareholder communications.

The fund primarily invested in non-agency mortgage-backed securities (NA MBS) and, during the relevant period, the fund’s investments consisted almost entirely of odd lot positions.  The fund was part of a series trust whose board delegated most valuation responsibilities to the fund’s administrator.  The administrator relied on prices provided by pricing vendors (Vendors) for the fund’s securities and submitted prices received from Vendors to the adviser for its review.  Vendors valued odd lot positions in NA MBS at round lot prices, which were typically higher than the purchase price paid by the fund for the odd lot positions.

Under the fund’s valuation procedures, the adviser had the ability to challenge valuations received from Vendors if the adviser believed that a Vendor’s price did not represent market value, and provide its own recommendation if the adviser did not agree with the Vendor’s response to the challenge.  According to the Order, the adviser did not make an alternative recommendation or conduct further review or analysis on the appropriateness of a given price, nor did the adviser have a reasonable basis to believe that Vendor prices for the odd lot NA MBS positions accurately reflected the prices that the fund would receive for those positions in a current sale when a Vendor did not adjust its pricing and responded that it was using round lot pricing when questioned by the adviser.

During the relevant period, although price increases on NA MBS held by the fund due to round lot pricing were material contributors to the fund’s performance, the adviser did not disclose this fact in discussions of fund performance in shareholder reports and on an investor call, and instead attributed the fund’s performance to other factors, including the adviser’s investment process.

The SEC required the adviser to pay disgorgement of $103,228 (the adviser’s advisory fee for the entire period), prejudgment interest of $25,000 and a civil penalty of $375,000 for the conduct described in the Order.

The Order is available here: https://www.sec.gov/litigation/admin/2020/ia-5489.pdf


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Compliance, Enforcement Actions, Investment Advisers, Investment Companies, Regulatory