Mortgage-Backed Securities Fund Settles Action Keyed To Improper Valuation
The Commission filed a settled administrative proceeding on Monday which named as Respondents Evergreen Investment Management Company LLC, a registered investment adviser and Evergreen Investment Services, Inc., the adviser’s affiliated registered broker dealer. The proceeding is based on claimed violations of the Advisers Act and the Exchange Act. It centers on the incorrect pricing of the shares of Evergreen Ultra Short Opportunities Fund, which invested primarily in residential mortgage-backed securities and collateralized debt obligations backed by such securities. The proceeding also involves the selective disclosure of material non-public information to certain shareholders and improper transactions. In the Matter of Evergreen Investment Management Company, LLC, Adm. Proc. File No. 3-13507 (June 8, 2009).
From 2007 through 2008, Ultra Short Opportunities Fund was consistently ranked as a high performer in its class. If however, the Fund had followed proper valuation practices, it would have been ranked near the bottom of its category during this period, according to the Order for Proceedings.
During this period, the Fund’s NAV was overstated by as much as 17% due to a number of improper pricing practices. Ultra Fund valued many of its securities in accord with prices provided by a vendor such as Standard & Poor’s, PricingDirect, Interactive Data Corporation and Reuters. As early as February 2007, the Fund failed to take into account in its valuation of certain vendor-priced, broker-priced and/or portfolio management team-priced residential mortgage-backed securities readily available negative information about those securities. During part of that period, the Valuation Committee also valued one or more of the Fund’s securities in accord with prices obtained from a Florida based broker dealer whose valuation method had not been approved. At times, the Fund’s portfolio management team withheld relevant negative information from the Valuation Committee. As a result of these and other practices, investors were not given accurate information about the Fund.
In June 2008, the Valuation Committee began repricing a security held by the Fund and stopped using vendor overrides because of concern about the accuracy of the valuations. As securities were repriced, the NAV decreased. Because of concern about the impact of the repricing Evergreen Distributor prepared “talking points” for use by the wholesaler in response to inquiries. Those talking points indicated that the decline in NAV was the result of repricing and not market conditions. This information was made available to selected shareholders. Significant redemptions resulted.
Evergreen Adviser also caused other Evergreen mutual funds to purchase securities from the Ultra Fund. While such trades are generally prohibited by Section 17(a) of the Investment Company Act, Rule 17a-7 permits affiliated cross trades if, among other things, they are executed at a price equal to the average of the highest current independent bid to purchase the security and the lowest current independent offer to sell that security. The purchases here were at a price other than that average and in some instances the Fund’s portfolio management team did not even obtain the necessary pricing information. Evergreen Distributor also failed to preserve text and instance messages as required.
To resolve the matter, the Respondents, whose cooperation was acknowledged, consented to a censure and the entry of a cease and desist order. In addition, Evergreen agreed to pay more than $40 million as part of the settlement. Approximately $33 million was paid to compensate fund shareholders. An additional $3 million in disgorgement along with a $4 million penalty was also paid.