On January 27, 2014, the SEC issued two orders instituting administrative and cease-and-desist proceedings against Western Asset Management Co., an investment adviser headquartered in Pasadena, California.
The first SEC order alleges that, due to a coding error in the firm’s compliance system, in 2007, Western Asset allocated to its ERISA client accounts a restricted private placement that the issuer had deemed non-ERISA eligible. The order further alleges that, upon discovering the coding error, Western Asset identified the affected client accounts but did not immediately notify the clients or correct the error, in violation of Western Asset’s compliance policies and procedures and, in particular, its error correction policy. Rather, Western Asset, based on the factual investigation and legal analysis of inside and outside counsel, determined that there had been no breach of client guidelines and no “prohibited transactions” under ERISA, and therefore, did not notify its affected clients or offer to make the clients whole for any losses attributable to the security. The order states that, by the time Western Asset sold all of the holdings in the private placements in 2009, the sales prices were “materially lower” than the purchase prices, and Western Asset did not notify its clients that it had erroneously purchased the security until 2010, by which time Western Asset was aware of the SEC investigation. The SEC’s order alleges that Western Asset’s conduct resulted in violations of Sections 206(2) and (4) of the Advisers Act and Rule 206(4)-7 thereunder.
The second SEC order alleges that between 2007 and 2010, Western Asset effected improper cross trades between its advisory clients, including mutual fund and ERISA accounts, whereby dealers purchased fixed-income securities from certain Western Asset clients and then resold the same securities to other Western Asset clients. The order alleges, in particular, that (1) Western Asset favored its buying clients over its selling clients and failed to seek best execution for its selling clients as a result of it executing sale transactions at the highest current independent bid price rather than at an average between the highest bid and ask prices, (2) Western Asset executed the repurchase transactions at a small markup over the sale price and paid the markup to dealers to compensate them for their costs in the transactions, and (3) both such practices caused Western Asset’s mutual fund clients unknowingly to violate Section 17 of the 1940 Act. The order also stated that such cross trades were inconsistent with Western Asset’s compliance policies and procedures, and since its cross trade compliance policies were published in its Form ADV, Western Asset’s Forms ADV filed in 2007–2010 contained materially false statements regarding Western Asset’s cross trading. The SEC’s order alleges that Western Asset’s conduct resulted in violations of Sections 206(2), 206(4) and 207 of the Advisers Act and Rules 206(4)-7 and 206(4)-8(a)(2) thereunder, and, as a result of Western Asset’s conduct, it willfully aided and abetted and caused certain of its mutual fund clients to violate Sections 17(a)(1) and 17(a)(2) of the 1940 Act.
With respect to both orders, without admitting or denying the SEC’s findings, Western Asset agreed to settlements, pursuant to which, it was censured and ordered to cease and desist from committing or causing any further such violations, to make compensatory payments to affected clients of approximately $17.4 million in the aggregate and to pay penalties to the SEC and the Department of Labor of approximately $3.6 million in the aggregate.