[14064]
October 18, 2001
TO: COMPLIANCE ADVISORY COMMITTEE No. 50-01
INVESTMENT ADVISER MEMBERS No. 26-01
SEC RULES MEMBERS No. 69-01
RE: SEC SANCTIONS INVESTMENT ADVISERS FOR SECURITIES LAW VIOLATIONS
The Securities and Exchange Commission, in a recent administrative proceeding,
sanctioned an investment adviser and its subadviser for failing to reasonably supervise the
subadviser’s portfolio manager who, over a two-year period, defrauded a mutual fund and an
offshore fund.1 The Commission’s order sanctioned both advisers for failing to have in place
adequate policies and procedures designed to prevent the portfolio manager’s securities
violations. A copy of the order is attached, and it is summarized below.
Inflated Pricing Scheme
According to the Commission’s order, the portfolio manager engaged in a fraudulent
scheme where, without proper authority, she caused the mutual fund and the offshore fund to
purchase notes through private placements. She then defrauded the funds by inflating the
prices for the notes, despite the issuers’ financial problems, and then rolling up the distressed
notes into shell companies and inflating the prices of the shell companies’ notes.
The Commission found that in calculating the funds’ net asset values, the portfolio
manager failed to abide by the funds’ pricing procedures with respect to securities for which
market quotations were not readily available. Rather than obtaining bid and ask quotes from
two brokers as required, the manager set the bid and ask quotes for the notes herself through
discussions with the broker-dealer from whom she purchased the notes. The Commission also
found that the portfolio manager overstated the value of the notes by failing to take into account
the notes’ performance and the issuers’ financial condition. The Commission determined that
this inflated pricing resulted in the material overstatement of the net asset value of one of the
funds.
1 In the Matter of Western Asset Management Co. and Legg Mason Fund Adviser, Inc., Release No. IA-1980;
Administrative Proceeding File No. 3-10600, (September 28, 2001).
2
Failure to Supervise
The Commission found that both the subadviser and the adviser failed to reasonably
supervise the portfolio manager. With respect to the subadviser, the Commission found that it
failed to establish and implement adequate procedures regarding the purchase, monitoring and
pricing of private placement securities. In particular, the portfolio manager (1) did not have the
proper authority to enter into the private placement transactions, (2) was able to conceal from
the funds and the advisers that the notes’ issuers were suffering severe financial problems, and
(3) was able, without detection, to inflate the value of the troubled notes, which caused one of
the funds to materially overstate its net asset value.
With respect to the adviser, the Commission found that it failed to have adequate
policies and procedures in place to respond adequately to readily apparent “red flags” that
indicated that the portfolio manager was overstating the value of one of the fund’s securities.
For example, the Commission noted that when the adviser learned that stale pricing was
occurring for several of the notes it failed to adequately follow-up and determine the cause of
the problem. Also, when presented with an earlier proposed roll up transaction involving one
of the funds, the adviser failed to reasonably investigate the reason for the transaction, other
than to deny the request. According to the Commission, such an investigation would have
detected the underlying irregularities.
Without admitting or denying the Commission’s findings, the subadviser and the
adviser each agreed to pay a civil money penalty of $50,000 and to comply with an undertaking
to maintain the enhanced supervisory policies and procedures they each previously had
adopted.
Barry E. Simmons
Associate Counsel
Attachment
Note: Not all recipients receive the attachment. To obtain a copy of the attachment, please visit our members website
(http://members.ici.org) and search for memo 14064, or call the ICI Library at (202) 326-8304 and request the
attachment for memo 14064.
Attachment (in .pdf format)