U.S. securities regulators Monday announced charges against eight former board members of mutual funds run by Morgan Keegan for violating their asset pricing responsibilities under the federal securities laws.
The U.S. Securities and Exchange Commission (SEC) alleges that the funds, which were invested in securities backed by subprime mortgages, fraudulently overstated the value of their securities as the housing market was on the brink of financial crisis in 2007. The SEC and other regulators previously charged the funds’ managers with fraud, and the firms later agreed to pay US$200 million to settle the charges.
The SEC says that, under the securities laws, fund directors are responsible for determining the fair value of fund securities for which market quotations are not readily available. And, according to the SEC’s order instituting administrative proceedings against the eight directors, they delegated their fair valuation responsibility to a valuation committee without providing meaningful substantive guidance on how fair valuation determinations should be made.
It claims that the fund directors then made no meaningful effort to learn how fair values were being determined; that they received only limited information about the factors involved with the funds’ fair value determinations, and obtained almost no information explaining why particular fair values were assigned to portfolio securities.
The allegations against the directors have not been proven.
“Investors rely on board members to establish an accurate process for valuing their mutual fund investments. Otherwise, they are left in the dark about the value of their investments and handicapped in their ability to make informed decisions,” said Robert Khuzami, director of the SEC’s division of enforcement. “Had the board not abdicated its responsibilities, investors may have stood a better chance of preserving their hard-earned nest assets.”
The SEC enforcement division’s asset management unit continues to prioritize asset valuation investigations, it notes.
Attorneys for the former independent directors charged in the case (six of the eight individuals) issued a statement Monday emphatically denying the SEC’s allegations against them, promising to vigorously defend the charges, and saying they are confident that they will ultimately be vindicated.
“The SEC has chosen to ignore a host of facts and circumstances which demonstrate that these directors at all times acted diligently and in good faith during the unprecedented market turmoil of 2007,” they say in their statement; insisting that they were defrauded by the funds’ management, “who concealed improper valuation practices from them.”
The independent directors also say that they relied on expert opinions that the funds’ valuation procedures were sound, from a major accounting firm and the funds’ chief compliance officer; and, they say that an SEC compliance exam in 2005 “produced no adverse comments on the fair valuation procedure or process”.
They argue that the SEC is trying to send a message to fund directors with an enforcement action that, they say, would hold them to “standards not applicable at the time… based on allegations not supported by the actual facts and circumstances.”
The two other directors also issued a statement protesting their innocence, and calling the SEC action troubling. “The SEC seeks to impose liability for alleged failures to meet never-before-articulated standards for director involvement in day-to-day fund operations,” they said, adding that they will vigorously defend themselves against the charges.