WASHINGTON — Milwaukee-based Heartland Advisors Inc., its president and CEO William J. Nasgovitz, and five other current or former employees have agreed to pay a total of almost $4 million to settle Securities and Exchange Commission charges that they negligently violated securities fraud and investment advisory fraud laws by mispricing bonds in two now-defunct high-yield municipal bond funds.
Heartland Advisors, which was registered as an investment adviser and broker-dealer, as well as Nasgovitz, who is also president and a director of the mutual fund company Heartland Group, together were fined $3.5 million, which appears to be the largest civil penalty in a mispricing case, according to SEC officials.
The SEC also imposed civil penalties, disgorgement of ill-gotten gains, and prejudgment interest of: $95,001 against Paul T. Beste, chief operating officer of Heartland Advisors, a member of its pricing committee and a vice president of Heartland Group; $95,001 against Thomas J. Conlin, former co-portfolio manager of the muni funds, vice president, and non-voting member of the pricing committee; $162,961 against Greg D. Winston, former vice president, co-portfolio manager, and alternate on the pricing committee; $25,001 against Kevin D. Clark, senior vice president of trading; and $29,130 against Kenneth J. Della, former senior vice president and treasurer and a member of the pricing committee.
The SEC also imposed 12-month suspensions from the securities investment advisory industries against Winston and Della for liquidating their shares of the mutual funds prior to a dramatic devaluation of the funds.
The commission further sanctioned, with no fine, Hugh F. Denison, an independent director of the funds.
The firm and individuals neither admitted nor denied the SEC’s findings.
“We’re pleased to have this matter put behind us,” Beste said yesterday.
But SEC officials declined to comment on the settlement because commission charges remain pending in a federal court in Milwaukee against Jiliane H. Bauer, former general counsel, chief compliance officer, and head of the pricing committee for Heartland Advisors.
The case revolves around two high-yield bond funds created in 1997 that were invested primarily in non-rated medium and lower quality municipal bonds — the Short Duration High-Yield Municipal Fund and the High-Yield Municipal Bond Fund. Most of the bonds owned by the funds were below investment grade and illiquid, according to the SEC.
During late 1999 and early 2000, the funds’ portfolio managers discovered that projects underlying several bonds held by the funds had gone into default and that other projects were failing. But FT Interactive Data Corp., now Interactive Data, the pricing service used for the funds at the time, did not reduce its valuations of the affected bonds after learning of the defaults.
Between March and May of 2000, FTID gradually lowered its valuations of certain bonds in the funds to minimize the impact of the actions on the funds’ net assets values. But the lowered valuations were not based on any contemporaneous market or credit-related events, according to the SEC. Under investment laws, securities in mutual funds for which market quotations are not readily available should be based on “fair value as determined in good faith by the board of directors.” The fair value is the price that a fund might reasonably expect to receive for the sale of the security.
By spring 2000, the funds were also experiencing liquidity problems. At an Aug. 10, 2000, meeting, Conlin warned the directors of the funds that if forced to sell the bonds owned by the funds that day, a discount from current valuation would be required, but that sales over a week would not have that effect. The directors directed Heartland Advisors to sell bonds owned by the funds to reduce the funds’ borrowings, but it did not do so, according to the SEC. Conlin resigned from the firm soon after that.
But the funds prospectus’ continued to state that Heartland Advisors was managing the associated risks.
In late September, Heartland Advisors sold some of the funds’ most illiquid bonds to the State of Wisconsin Investment Board after Nasgovitz and a company he controlled agreed to guarantee to the board that it would recover its investment plus a 20% return.
On Sept. 28, the firm reduced the net asset values of the funds by 8.2% and 2.1% but failed to disclose this in a press release announcing Conlin’s departure and new portfolio managers.
That same day, Winston and relatives he contacted redeemed a total of 9,531 shares of the funds. On Oct. 10, Della also redeemed shares of the funds for himself and accounts over which he had discretionary authority.
On Oct. 13, the pricing committee assigned new values to the bonds held by the funds and the net asset values of the funds fell by 69.4% and 44.0%, resulting in about $60 million in monetary losses to shareholders.
In March 2001, the SEC convinced a court to shut down the two funds.
In December 2003, the commission filed securities fraud and investment advisory fraud charges against Heartland Advisors and nine individuals and settled charges of aiding and abetting fraud against FT Interactive for $125,000.
The SEC had charged Nasgovitz and investor Raymond R. Krueger with insider trading, but a federal judge in Milwaukee threw out those charges in 2006 after concluding the commission had not provided enough evidence to proceed with the charges.