by T. GormanPosted on Posted in SECActions

The SEC filed its third asset valuation action in recent weeks. This time the proceeding named as Respondents eight mutual fund directors for failing to properly oversee the valuation of assets in the funds during the market crisis. In the Matter of J. Kenneth Alderman, CPA, Adm. Proc. File No. 3-15127 (Filed December 10, 2012). Previously the Commission brought similar actions against KCAP Financial and two executives at the firm and Yorkville Advisors LLC and its officers. KCAP settled. The civil injunctive action involving Yorkville, and the Alderman proceeding did not.

Six of the eight Respondents in Alderman are independent directors and members of the audit committee of the funds: 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 Funds involved were four closed end and one open ended fund. Each 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 Stone. The investment adviser was Morgan Asset Management, Inc.

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. Those 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 on a daily based 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 by Fund Accounting and the Valuation Committee to fair value the particular securities or types of securities. Likewise, they 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 its 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.

The Order alleges that the Respondents caused the Funds’ violations of Rules 22c-1, 30a-3(a) and 38a-1 of the Investment Company At of 1940. A hearing will be set in this matter.

Hurricane Sandy: As we enjoy the holiday season please remember the victims of Sandy’s destruction with a donation to the Red Cross (here).

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by T. GormanPosted on Posted in SECActions

Enforcement officials have brought what seems to be an endless stream of Ponzi scheme and investment fund fraud cases in recent years. Once exposed the schemes often appear simple and obvious which may leave many wondering how investors were duped into parting with their funds.

The reality is quite different, a point well illustrated by the SEC’s most recent investment fund fraud case, SEC v. Innovida Holdings, LLC, Case No. 1:12-cv-24326 (S.D.Fla. Filed Dec. 7, 2012). Innovida Holdings was a manufacturer of innovative, energy efficient products. Its website described the company as a manufacturer of “building solutions that bridge the gap between energy efficiency, affordability and high quality. Using its proprietary technology, Innovida manufactures fiber composite panels which are used to build residential, commercial, government, military . . . structures without the use of cement, steel, or wood and with significant savings . . . and [which] are energy . . . “ efficient.

The company had a solid board of directors and management. The board included a former Florida governor, a lobbyist and a successful real estate developer. Its CEO was defendant Claudio Osorio who was also a member of the board. His is a former Ernst & Young Entrepreneur of the Year Award winner. Its CFO was defendant Craig Toll, a well established certified public accountant in Florida. The company products apparently met Miami-Dade Country hurricane code requires and were used to build homes in the area.

This appearance of legitimacy was used by Mr. Osorio to raise about $16.8 million from five investors in 2009 and 2010. In September 2009 one investor purchased $100,000 of Mr. Osorio’s interest in the company for a five percent stake in the company. At the time the investor was told that the company was worth about $50 million. That representation followed one made to other investors earlier in the month who had attended a board of directors meeting that the company was valued at $250 million. In fact Mr. Orsorio had no basis for either representation. At the time the investor was induced to purchase a stake in the company it had less than $40,000 in cash or cash equivalent assets.

Another investor put $312,000 in the company, also in September 2009. At the time he relied Mr. Osorio claim that had tens of millions of dollars in his own funds in the company. In fact he did not.

In October 2009 Mr. Osorio raised about $16.8 million from five investors. The funds were to grow the business. In fact Mr. Osorio used about half of the money for himself.

Another investor was induced to add $3.7 million to his initial investment based on the claim that a sovereign wealth fund would buy units from existing shareholders at $2.50 per share. There was no deal with a sovereign wealth fund.

Eventually an investor began a state court action against the company which resulted in the appointment of a receiver. The company ended in Chapter 11 bankruptcy.

The Commission’s complaint alleges violations of Exchange Act Section 10(b) and each subsection of Securities Act Section 17(a). The case is in litigation. See also Lit. Rel. No. 22563 (Dec. 7, 2012).

Hurricane Sandy: As we enjoy the holiday season please remember the victims of Sandy’s destruction with a donation to the Red Cross (here).

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