In civil actions filed today, the SEC charged the following entities and individuals:
- Heartland Adivsors, Inc.;
- William Nasgovitz, its President and CEO;
- Paul Beste, its COO;
- Jilaine Bauer, its General Counsel;
- Kevin Clark, its Senior Vice President of Trading;
- Kenneth Della, its Treasurer;
- Thomas Conlin and Greg Winston, former portfolio managers;
- Hugh Denison, an associated Director;
- John Hammes, Dr. Gary Shilling, Allen Stefl, and Linda Stephenson, all Independent Directors;
- FT Interactive Data Corp., an independent pricing service, and
- Raymond Krueger, a friend and client of Nasgovitz.
Heartland Advisors (Heartland), a Milwaukee investment adviser, manages the Heartland Group complex of mutual funds. The Commission's actions alleged violations in three primary areas -- fund pricing, insider trading, and disclosure -- and relate to two high-yield municipal bond funds managed by Heartland (the Funds). The value of the Funds, and a smaller related fund, dropped by approximately $93 million between Sept. 28 and Oct. 13, 2000, when Heartland sought to correct months of deliberate mispricing.
In its complaint, the Commission charged Heartland, Nasgovitz, Beste, Bauer, Clark, Conlin, and Della with fraudulently pricing bonds in the Funds. The Commission further alleged that the Funds' directors caused certain of Heartlands' pricing violations when they failed to adequately follow up and resolve concerns about pricing issues that came to their attention. The Commission charged FT Interactive with aiding and abetting and causing certain Heartland pricing violations.
The Commission also charged that Nasgovitz, Bauer, Winston, Della and Krueger engaged in insider trading in the shares of the Funds when they sold their shares, and/or tipped others to do so, while aware that the Funds had liquidity and pricing problems.
In the disclosure area, the Commission charged that Heartland, through Nasgovitz, Beste, Bauer, Clark, Conlin and Winston, misrepresented and omitted material facts in the offer and sale of shares in the Funds. The misrepresentations and omissions related to the risks of investing in the Funds, the credit research on the bonds purchased and held by the Funds, the credit quality of the bonds held in the Funds and the liquidity of the Funds.
Stephen M. Cutler, Director of the SEC's Division of Enforcement, said, "Accurate pricing of mutual fund shares is among the most critical responsibilities of a fund and its adviser. Investors need the best possible information on the value of their shares to make informed investment decisions. In this case, the unfairness that flows from improper pricing was compounded by alleged insider trading by Heartland officers who, unlike other investors, were aware of the Funds' liquidity problems."
Mary E. Keefe, Regional Director of the SEC's Midwest Regional Office in Chicago, stated, "The fraud in this case touched all levels of the operations of these mutual funds and two areas critical to investor confidence, disclosure and pricing. It illustrates that mutual fund directors must do more than inquire about issues that come to their attention. They have a duty to take affirmative action to follow up and resolve those issues in order to fulfill their obligations to investors under the Investment Company Act."
The SEC's complaint, filed today in the United States District Court for the Eastern District of Wisconsin, alleges the following:
- Heartland, through Nasgovitz, Beste, Bauer, Clark, Conlin and Winston misrepresented the Funds' NAVs and, in Commission filings and promotional materials, their efforts to manage certain risks associated with investing in the Funds. For example, Heartland represented that it was actively managing the Funds to minimize share price fluctuation when it was not doing so. Heartland also represented that it performed intensive credit research and limited the percentage of unrated high yield bonds held by funds. In reality, Heartland conducted inadequate research and the vast majority of bonds held by the Funds were unrated and relatively illiquid. Finally, Heartland misrepresented that it and the Funds' Board of Directors would monitor and maintain sufficient liquidity in the Funds' portfolio holdings to assure that the Funds would be able to meet redemptions. They did not do so. Instead the Funds had to borrow millions to meet redemptions. As a result, by mid-2000 the Funds were suffering a cash flow crisis.
- The root of this problem was that Heartland, in order to protect the Funds' performance, refused or failed to adjust the prices of the Funds' securities despite numerous indications that the bonds held by the Funds could only be sold at substantial discounts to their carrying values. Heartland later arranged a purported "sale" of those bonds that, in reality, more closely resembled a short-term loan to temporarily infuse cash into the Funds. Nevertheless, the substantially discounted "sale" prices of those bonds caused the Funds' NAVs to drop materially on Sept. 28, 2000 (the September Devaluation). Thereafter, Heartland misrepresented to investors the cause of the September Devaluation. Faced with continuing redemptions and consequent cash flow problems, which caused it to consider suspending redemptions, on October 13, Heartland repriced most of the bonds in the Funds' portfolios by taking an across-the-board discount. This resulted in another substantial drop in the Funds' NAVs (the October Devaluation). Again, Heartland misrepresented the real reason for this drop in the Funds' NAVs.
- While investors were kept in the dark about the Funds' problems, Nasgovitz tipped Krueger about the Funds' continuing liquidity and/or pricing problems prior to the September Devaluation, and Krueger liquidated his shares in one of the Funds. In addition, with knowledge of the Funds' continuing liquidity and pricing problems: Winston, a portfolio manager of the Funds, liquidated his shares in the Funds and tipped his family to do the same; Bauer liquidated her shares in one of the Funds; and Della liquidated his shares in the Funds and redeemed his father's shares in a related fund.
In the federal district court action, Heartland, Nasgovitz, Beste, Bauer, Clark, Conlin, Winston and Della are charged with violating or aiding and abetting violations of the antifraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Advisers Act of 1940 and the Investment Company Act of 1940. They are also charged with breaching their fiduciary duties under the Investment Company Act, and all but Della are charged with misrepresentations or omissions in certain records required under the Investment Company Act. Denison is charged with violations of the antifraud provisions of the Securities Act and for breaching his fiduciary duties under the Investment Company Act for failing to adequately monitor the liquidity of the Funds and to take adequate steps to address the Funds' pricing deficiencies. The Commission is seeking permanent injunctions against these defendants as well as disgorgement, pre-judgment interest and civil penalties.
In separate administrative proceedings, FT Interactive consented to the issuance of an order by the Commission finding that it caused and willfully aided and abetted Heartland Advisors' violations of the antifraud provisions of the Investment Advisers Act and the fund pricing provision of the Investment Company Act. In that order, the Commission also censured FT Interactive, ordered it to cease and desist from committing or causing the above violations, ordered it to pay a $125,000 civil penalty and ordered it to comply with certain undertakings regarding the pricing of securities for which market quotations are not readily available. FT Interactive neither admitted nor denied the Commission's findings.
In another administrative proceeding, the Commission issued an order, also by consent, requiring Hammes, Shilling, Stefl and Stephenson to cease and desist from committing or causing violations of the antifraud provisions of the Securities Act and the fund pricing provision of the Investment Company Act, for their negligent failure to adequately monitor the liquidity of the Funds and to take adequate steps to address the Funds' pricing deficiencies. Hammes, Shilling, Stefl and Stephenson neither admitted nor denied the Commission's findings. In accepting the Independent Directors' offer of settlement, the Commission considered the facts that the respondents were lied to by the Funds' adviser regarding the status of the Funds, hired experts to assist them in performing their duties and engaged in subsequent remedial actions. Nevertheless, though the directors inquired about the pricing and liquidity issues that came to their attention, they did not go far enough in following through and resolving those issues as required by their duties arising under the Investment Company Act.
