Heartland Fund Fraud Alleged
The Securities and Exchange Commission charged Heartland Advisors Inc. and several top executives with civil fraud Thursday in the latest move in the ever-widening probe of mutual fund misdeeds.
Leveling an unusually broad array of charges, federal regulators said that Heartland Advisors Chief Executive William Nasgovitz and 11 others -- including four independent directors and an independent pricing service -- misrepresented the risks of investing in the Milwaukee-based company’s high-yield funds and the value of the funds’ underlying assets.
Also, the agency said that several Heartland executives and one well-connected customer had improperly traded in their own accounts or tipped off friends and family to sell shares prior to revealing the funds’ problems to the outside world.
“Accurate pricing of mutual fund shares is among the most critical responsibilities of a fund and its advisor,” said Stephen M. Cutler, director of the SEC’s Division of Enforcement. “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.”
Six executives were charged with fraudulently pricing bonds within the funds: Nasgovitz; Chief Operating Officer Paul Beste; General Counsel Jilaine Bauer; Kevin Clark, senior vice president of trading; Treasurer Kenneth Della; and Thomas Conlin, a portfolio manager.
Insider trading charges were filed against Nasgovitz, Bauer, Della, portfolio manager Gregory Winston and Raymond Krueger, a friend and client of Nasgovitz.
In a related move, the SEC issued a consent order requiring four of Heartland’s independent directors -- John Hammes, Gary Shilling, Allen Stefl and Linda Stephenson -- to cease and desist violating securities laws through “their negligent failure to adequately monitor the liquidity of the funds and to take adequate steps to address funds’ pricing deficiencies.”
They agreed to the order without admitting or denying any wrongdoing.
Heartland said in a prepared statement that it was disappointed with the SEC’s decision to litigate the case, which stemmed from 3-year-old problems with bond funds that Heartland no longer manages.
The company specifically denied the insider trading charges related to Nasgovitz and said it would vigorously contest the other charges.
Attorneys for the Heartland officers didn’t return phone calls.
David Cannon, a Milwaukee attorney for Krueger, said his client had done nothing wrong and would be vindicated in court.
Heartland, according to the SEC suit, claimed in prospectuses and other documents that the company carefully managed its high-yield bond portfolio, attempting to frequently monitor market prices, reduce investor risks and maintain proper liquidity. In reality, the fund was neglected and, by mid-2000, was suffering a severe liquidity crunch, which forced the company to borrow millions of dollars to handle cash demands of departing investors, the SEC suit alleges.
Heartland’s executives knew that many of the bonds in the portfolio were being held at inflated prices, the SEC charges. However, the agency says, the fund did not mark the bonds to their proper values until the fall, improperly inflating the company’s net asset value -- the price at which shareholders trade their shares -- in the interim.
Finally, in late September and early October, the fund “re-priced” a group of the bonds, slashing the net asset values of the funds by $93 million, according to the suit.
Prior to the re-pricings, Nasgovitz told Krueger about the funds’ continuing liquidity and pricing problems, the suit says, causing Krueger to sell his shares in one of the funds. Winston, a portfolio manager, also liquidated his shares and told his family to do the same; Bauer sold her shares in one of the funds; and Della liquidated his shares and his father’s shares in a related fund, according to the SEC.
The SEC action suggests that mutual fund investigations, at both the federal and state levels, continue to break new ground and that mispricing of high-yield bond funds has emerged as a major focus of investigative scrutiny.
Until now, most of the revelations have focused on illicit late trading and abusive market-timing in stock mutual funds.
“We are definitely looking at the portfolio holdings of high-yield bond funds,” one SEC official said, adding that investigators were examining “the pricing of underlying securities, particularly high-yield bonds in bond funds.”
Thursday’s charges put pressure on fund directors to monitor fund operations more closely, said Nell Minow, editor of a corporate governance Web site called the Corporate Library.
“The SEC made it absolutely clear that board members cannot just collect their paychecks,” she said. “If they see evidence of a problem, they need to retain counsel and launch their own investigation.”
*
Peterson reported from Washington, Kristof from Los Angeles.
