Fund Directors, SEC Settle After Two of Three Claimed Violations are Dropped
The Commission settled with eight mutual fund directors regarding the procedures used in the valuation of certain assets after months of litigation. In the Matter of J. Kenneth Alderman, CPA, Adm. Proc. File No. 3-15127 (June 13, 2013). The proceeding , initiated in December 2012, named as Respondents directors at four open ended funds and one closed end fund. Each fund had a board of directors composed of two interested and four independent directors. All of the independent directors were members of the audit committee, chaired by Respondent Mary Stone. The six independent directors named as Respondents were: Jack Blair; Albert Johnson; James Stillman McFadded; W. Randall Pittman; Mary Stone; and Archie Willis. Also named were directors J. Kenneth Alderman and Allen Morgan. The investment adviser was Morgan Asset Management, Inc.
The Order which initiated the proceeding centered on claims that certain assets had been incorrectly valued resulting in false filings as the market crisis unfolded. At the end of the first quarter 2007 the Funds had a combined net asset value of about $3.85 billion. Large portions of those assets were invested in complex structured products such as collateralized debt obligations and similar instruments. The assets were concentrated in below investment grade debt securities which carried inherent risks. For many of the structured products there were no readily available market quotations. As a result a large percentage of the Funds’ portfolios had to be fair valued by the boards.
Under the Policy and Procedure Manual for the Funds the directors delegated to Morgan Asset the responsibility for carrying out certain functions related to valuation of the portfolio securities in connection with calculating the NAV per share. While the Funds’ Valuation Procedures listed a series of factors to be considered, many of which were drawn from the pertinent literature, they provided no meaningful methodology or other specific direction on how to make the fair value determination.
The actual task of assigning fair values was performed by Fund Accounting, a function staffed by Morgan Keegan employees. In making their determinations of fair value, the Order alleges that no reasonable analytical method was used.
Throughout the period the directors were unaware of the methodology utilized to fair value the particular securities or types of securities, according to the Order. Likewise, the Respondent directors failed to inquire about the methodology used.
As a result of the failure by the Directors to cause the Funds to adopt and implement reasonable procedures, the NAVs of the Funds were materially misstated from the end of March 2007 through early August of that year. Thus the prices at which the open ended Fund sold, redeemed and repurchased shares were inaccurate. At least one registration statement, and other filed reports, contained NAVs that were materially misstated. The Form N-1A filed by the Select Fund for October 29 2007 that contained NAVs as of June 30, 2007 that were materially overstated, according to the Order that initiated the proceeding.
The Order alleged that the Respondents caused the Funds’ to violate: Rules 22c-1 of the Investment Company Act which makes it unlawful to sell, redeem or repurchase redeemable securities except at a price based on the current net asset value; Rule 30a-3(a) which requires that registered management investment companies maintain internal control over financial reporting; and Rule 38a-1 which requires that the registered investment company adopt and implement written policies and procedures reasonably designed to prevent a violation of the federal securities laws by the fund.
Respondents and the Commission agreed to settle the proceeding following litigation but prior to a hearing. Each Respondent consented to the entry of a cease and desist order based only on Rule 38a-1. No monetary relief was directed. The allegations in the original Order alleging violations of Rules 22c-1 and 30a-3(a) were deleted from the refilled Oder. Also deleted were claims that the NAVs of the Funds were materially misstated from the end of March 2007 through early August of that year; that at least one registration statement and other filed reports were materially misstated; and that the Form N-1A filed by the Select Fund for October 29 2007 that contained NAVs as of June 30, 2007 that were materially overstated.
ABA Seminar: Fifth Annual FCPA Update: Protecting Your Business in the Future: Lessons from the New DOJ-SEC FCPA Guide, June 19, 2013 from 1:00 -2:30 p.m. EST. The discussion will focus on building effective compliance systems and conducting M&A due diligence. Co-moderators: Thomas Gorman and Frank Razzano. Panel: John Buretta, Principal Deputy to the Assistant AG, DOJ; Charles Cain, Assistant Director, FCPA Unit, SEC Division of Enforcement; Catherine Razzano, Assistant General Counsel, General Dynamics Corporation; Steve Siegal, Senior Counsel, Northrop Grumman Corporation; Ryan Ong, President, U.S. China Business Counsel. Live in Washington, D.C at 600 14th St. N.W., Penthouse (no charge for ASECA members attending live in Washington who pre-register by sending an e-mail to email@example.com). Webcast nationally by the ABA and available in other Dorsey & Whitney offices. For further information please click here.