SEC Charges Advisory Firms and Portfolio Managers for Roles in Collapse of Midwest-Based Closed-End Fund
The Securities and Exchange Commission today charged two investment advisory firms and two portfolio managers responsible for managing a Midwest-based closed-end fund for their roles in the failure to adequately inform investors about the fund’s risky derivative strategies that contributed to its collapse during the financial crisis.
An SEC investigation found that the Fiduciary/Claymore Dynamic Equity Fund (HCE) attempted two strategies to enhance returns — writing out-of-the money put options and shorting variance swaps. This exposed HCE to additional undisclosed risks and caused the fund to lose more than $45 million in September and October 2008, which was approximately 45 percent of its net assets. The fund liquidated in 2009.
Fund adviser and administrator Claymore Advisors LLC, which is located in Lisle, Ill., and the sub-adviser responsible for managing HCE’s portfolio, St. Louis-based Fiduciary Asset Management LLC (FAMCO), agreed to settle the SEC’s charges. Claymore has established a plan to distribute up to $45 million to fully compensate investors for losses related to the problematic trading. FAMCO agreed to pay an additional $2 million in disgorgement and penalties. The SEC’s case continues against former FAMCO employees Mohammed K. Riad of Clayton, Mo., and Kevin Timothy Swanson of St. Louis, the co-portfolio managers who allegedly made misleading statements in HCE’s periodic reports about the two strategies’ contribution to HCE’s performance and about HCE’s exposure to downside risk.
“When discussing fund performance and risks, fund advisers must candidly and accurately portray how the fund is being managed. The disclosures in this case fell short of the mark,” said Robert J. Burson, Senior Associate Regional Director of the SEC’s Chicago office.
The SEC’s investigation was conducted by the Chicago office and the Enforcement Division’s Structured and New Products Unit that focuses on derivatives and other complex financial products.
“Derivatives have the potential to vastly increase the amount of leverage and exposure for a fund. HCE was exposed to substantial undisclosed risks as a result of its use of these complex financial instruments, and investors weren’t sufficiently told,” said Kenneth Lench, Chief of the SEC Enforcement Division’s Structured and New Products Unit.
According to the SEC’s orders instituting the settled and unsettled administrative proceedings, FAMCO managed HCE in a manner that was inconsistent with the fund’s registration statement. Through the portfolio managers, FAMCO made misleading statements about HCE’s performance, omitting discussion of contributions from the put-writing and variance swap strategies. FAMCO also made misleading statements about HCE’s exposure to downside risk. Investors in HCE lost $45,396,878 as a result of this riskier trading, and the fund lost $70 million total (72.4 percent of its net asset value) during this period of general market decline.
The SEC’s order found that Claymore failed reasonably to supervise FAMCO as required by the firms’ investment advisory agreements, and found that Claymore caused HCE’s failure to provide adequate disclosure in HCE’s annual report or an amended registration statement about the fund’s use of written put options and variance swaps and their associated risks. Claymore consented to the order without admitting or denying the charges, and has established a distribution plan to fully reimburse shareholders for up to $45,396,878 in losses from these derivative transactions.
FAMCO agreed to pay disgorgement of $644,951, prejudgment interest of $134,978, and a penalty of $1.3 million. Without admitting or denying the charges, FAMCO agreed to be censured and to cease and desist from committing or causing any violations of Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8, and Section 34(b) of the Investment Company Act of 1940.
The case continues against Riad and Swanson, who the SEC Division of Enforcement alleges violated, aided and abetted, and/or caused violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, Section 206(4) of the Investment Advisers Act and Rule 206(4)-8, and Section 34(b) of the Investment Company Act. The Division also alleges that Riad caused violations of Investment Company Act Rule 8b-16.
The SEC’s investigation was conducted by Jeffrey A. Shank and Anne C. McKinley with assistance from Emmanouil Tsimouris and Susan M. Weis in the Office of Compliance Inspections and Examinations. Robert M. Moye will lead the SEC’s litigation. Related examinations of HCE, Claymore, and FAMCO were conducted by Mr. Tsimouris, Ms. Weis, Edward J. Wicherek, Michael R. Collins, Vanessa L. Horton, Walter H. Melcher, and Anthony J. Santoro under the supervision of Belinda A. Hoskins, Andrew D. Schuster, Maureen S. Dempsey, and David J. Mueller in the Chicago office.
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More Information About Claymore’s Plan For Reimbursing Investors:
Claymore has engaged The Garden City Group, Inc. as the Plan Administrator responsible for managing the distribution of up to $45,396,878 to reimburse former HCE shareholders for losses from the derivative transactions described in the SEC’s enforcement action. In implementing Claymore’s distribution plan, The Garden City Group will send a notice with additional information about the distribution and a claim form to all identified potentially eligible HCE shareholders who held shares of HCE between Aug. 19, 2008 and Oct. 20, 2008. Claymore will provide additional information about the distribution plan through a release and on its website. The Garden City Group also will provide information through a website. Any investor who would like more information about Claymore’s distribution plan should contact The Garden City Group at 855-590-8694 or www.HCEDistributionPlan.com.