On October 18, 2016, the SEC announced settled administrative proceedings against Calvert Investment Management, Inc. (the Adviser), a registered investment adviser, for improperly valuing bonds held by eight open-end mutual funds it advises (the Funds) and, consequently, executing shareholder transactions at an incorrect net asset value (NAV) and overstating performance. In addition, the SEC alleges that the Adviser collected inflated asset-based fees.
According to the SEC’s order, between March 2008 and October 2011, the Funds acquired more than $1.2 billion principal amount of bonds issued by Toll Road Investors Partnership II, L.P. (the Bonds), complex and illiquid securities that at times had minimal external data points to facilitate valuation. The order states that in determining the Bonds’ fair value, the Adviser relied primarily on the output of a third-party analytical tool. The SEC alleges that for an eight month period, the Adviser “failed appropriately to incorporate indicia of fair value into its fair value calculations, including, among others, the prices at which at which the [Funds] traded the [Bonds], values assigned by other holders of the [Bonds], and other market data.” In this regard, the order states that the Adviser’s fair value price was significantly higher than market prices paid by the Funds in purchases of the Bonds on several occasions, with “no clear indication that those trades involved distressed sales that might be afforded less weight in fair value calculations.” The SEC also alleges that the Adviser failed to back-test the Bonds’ fair value determinations, despite back-testing other portfolio holdings.
The SEC order states that on October 19, 2011, the Adviser discovered that the third-party analytical tool was flawed since it did not properly account for the Bonds’ future cash flows and, as result, substantially inflated the Adviser’s fair value prices. The order further states that the Adviser revised its approach and developed its own cash flow model to recalculate the Bonds’ fair value prices, with the effect of significantly reducing the fair value prices. Thereafter, the Adviser publicly stated that it had made a pricing adjustment resulting in decreased NAVs of the Funds.
The order notes that, in an attempt to remediate the harm caused by the improper valuation of the Bonds, the Adviser contributed $27 million to the Funds in December 2011 and distributed nearly all of the contributed amounts to accountholders of record as of October 19, 2011, with undistributed amounts retained by the Funds. However, the SEC alleges that the payment amount “was derived from an insufficient process, since it was neither based on complete transactional data nor otherwise effectuated in accordance with the [Funds’] existing policies and procedures,” and thus, the Adviser failed to compensate some shareholders and undercompensated others and the Funds. In this connection, the SEC alleges that the Adviser’s payment was an imprecise measurement of estimated harm to accountholders of record based on a netting out of subscription and redemption activity at the intermediary account level. Because the Adviser did not have data concerning underlying shareholder account activity in omnibus accounts, the SEC alleges that the remediation process was flawed and shareholders potentially received different distribution amounts depending on whether they transacted through an intermediary or directly with the Funds “despite having engaged in identical transactions in shares of the [Funds].” Although the Funds’ SEC filings and the Adviser’s communications disclosed that shareholders harmed by the improper valuation were accurately identified and made whole, the SEC alleges that the Funds and the Adviser failed to disclose that the remediation process was:
- based, in part, on an estimate and was inconsistent with the Funds’ NAV error correction procedures; and
- disparately treated certain shareholders, depending on whether they transacted directly with the Funds or through an intermediary.
As a result of the foregoing conduct, the SEC found that, among other things, the Adviser violated Sections 206(2) and 206(4) of the Advisers Act, which prohibit any fraud or deceit upon a client and the making of any untrue statement of material fact (or omission thereof) or otherwise engaging in any fraudulent deceptive or manipulative act with respect to any investor in a pooled investment vehicle, respectively. The SEC also found that the Adviser violated Sections 17(a) and 34(b) of the 1940 Act, which prohibit affiliates from selling securities to registered investment companies and the making of untrue statements of material fact in any document filed pursuant to the 1940 Act, respectively. Finally, the SEC found that the Adviser violated Rules 22c-1 and 38a-1 of the 1940 Act, which prohibits transacting in investment company securities other than at NAV and requires the implementation of policies and procedures to prevent violations of the federal securities laws, respectively.
Pursuant to the terms of the order, the Adviser agreed to, among other things, recalculate the fair value of the Bonds for the relevant period using a valuation methodology and prices provided to the SEC staff, reprice each Fund’s NAV, taking into account purchases and redemptions that occurred at incorrect NAVs and a performance adjustment, and thereafter, make distributions to accountholders pursuant to a detailed distribution methodology and processes set forth in the order. In addition, the Adviser was censured and agreed to pay a civil money penalty of $3.9 million and cease and desist from any violations (and future violations) of the laws violated by the foregoing conduct.
The SEC order is available at: https://www.sec.gov/litigation/admin/2016/ia-4554.pdf