Heartland Officials Charged in MispricingDec 12, 2003 | AP
Federal regulators opened a new front in the expanding mutual fund investigation, filing civil fraud charges against investment firm Heartland Advisors, its chief executive and five other officials for allegedly defrauding mutual fund investors by deliberately mispricing bonds in two funds.
The company disputed the allegations by the Securities and Exchange Commission brought Thursday in a civil lawsuit in federal court in Milwaukee. The two high-yield municipal bond funds had been terminated, it noted in a statement. Investors in the two funds and a related third fund lost an estimated $93 million in the fall of 2000.
The SEC also charged that William Nasgovitz, founder, president and CEO of the Milwaukee firm, and three other company executives compounded the unfairness of improper pricing by engaging in illegal insider trading in the high-yield municipal bond funds.
In its statement, Heartland Advisors called the insider-trading allegation related to Nasgovitz "completely untrue" and said he and the company "suffered losses alongside other shareholders" when the funds' value plummeted. Less than two weeks before the decline, Nasgovitz invested an additional $250,000 in the funds, the company said.
Attorneys for the three other company officials, general counsel Jilaine Bauer, treasurer Kenneth Della and former portfolio manager Greg Winston didn't return telephone calls seeking comment.
In a related administrative case, pricing service FT Interactive Data Corp. agreed to pay a $125,000 civil fine to settle the SEC's allegations that it aided Heartland Advisors' bond price violations. FT Interactive Data did not admit to or deny the allegations.
At the same time, four directors of Heartland Advisors accused by the SEC of "negligent failure" to adequately monitor the funds' cash flow and pricing, agreed to refrain from future violations of securities laws. The four: John Hammes, Gary Shilling, Allen Stefl and Linda Stephenson neither admitted to nor denied wrongdoing.
The SEC is seeking unspecified civil fines against the other defendants in the case.
It was the first case in regulators' pursuit of abuses in mutual fund trading involving the alleged deliberate use of so-called "stale pricing" of shares, in which ordinary investors were given an old price so insiders could cash in on changes in the true market value.
The previous cases in recent months, some involving prominent companies such as Putnam Investments and Prudential Securities, have mostly alleged illegal after-hours trading in mutual funds or market timing exploiting short-term movements in stock prices with quick "in and out" trading of fund shares, which is not illegal but violates the rules of most fund companies. The cases have centered on alleged fund trading abuses that favored selected investors, rather than manipulation of prices.
More cases involving "stale pricing" appear likely to come.
"It is a concern that we're going to be turning our attention to," said Daniel Gregus, an assistant regional director in the SEC's Midwest office in Chicago.
Mutual funds generally are priced only once a day, so events that happen shortly after funds are priced for the day could cause a big swing in the following day's price. That creates an opportunity to profit for those who can manipulate the system.
Stale pricing is said to be a particular problem for mutual funds with high-risk, high-yield bond funds, such as those at issue in the Heartland case, which don't register price changes regularly.
In March 2001, the SEC obtained a federal court order freezing the assets of three Heartland bond funds on grounds the company did not provide audited financial statements for the funds in a timely manner. Heartland said it had been unable to file the statements because its auditors at PricewaterhouseCoopers said they couldn't obtain objective, independent information on the share prices.
Also at the time, the court authorized a Chicago attorney to oversee Heartland Advisors' fund operations and sell the bonds if necessary.
The SEC said Thursday that the value of the two bond funds, and that of a smaller related fund, dropped by some $93 million between Sept. 28 and Oct. 13 of 2000 when the company tried to correct months of deliberate mispricing.
The agency also alleged that Nasgovitz and others failed to disclose significant information concerning investment risk and the bonds' credit quality in the sale of shares in the two high-yield bond funds.