Trudie D. Whitehead
SECURITIES ACT OF 1933
Release No. 8018 / September 28, 2001
SECURITIES EXCHANGE ACT OF 1934
Release No. 44875 / September 28, 2001
INVESTMENT ADVISERS ACT OF 1940
Release No. 1981 / September 28, 2001
INVESTMENT COMPANY ACT OF 1940
Release No. 25198 / September 28, 2001
ADMINISTRATIVE PROCEEDING
File No. 3-10601
In the Matter of TRUDIE D. WHITEHEAD, Respondent. |
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ORDER INSTITUTING PUBLIC ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDING, MAKING FINDINGS AND IMPOSING SANCTIONS AND CEASE-AND-DESIST ORDER |
I.
The Securities and Exchange Commission ("Commission") deems it appropriate in the public interest to institute a public administrative and cease-and-desist proceeding pursuant to Section 8A of the Securities Act of 1933 ("Securities Act"), Section 21C of the Securities Exchange Act of 1934 ("Exchange Act"), Sections 203(f) and (k) of the Investment Advisers Act of 1940 ("Advisers Act") and Sections 9(b) and (f) of the Investment Company Act of 1940 ("Investment Company Act") against Respondent Trudie D. Whitehead ("Whitehead" or "Respondent").
II.
In anticipation of the institution of this administrative proceeding, Whitehead has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings contained herein, except that Whitehead admits the jurisdiction of the Commission over her and over the subject matter of this proceeding, Whitehead consents to the entry of this Order Instituting Public Administrative And Cease-And-Desist Proceeding, Making Findings and Imposing Sanctions and Cease-and-Desist Order ("Order").
Accordingly, IT IS HEREBY ORDERED that a proceeding pursuant to Section 8A of the Securities Act, Section 21C of the Exchange Act, Section 203(f) and (k) of the Advisers Act and Sections 9(b) and (f) of the Investment Company Act be, and hereby is, instituted.
III.
On the basis of this Order and Whitehead's Offer, the Commission finds that:
A. SUMMARY
This matter involves a portfolio manager, Whitehead, who engaged in acts that resulted in the overstatement of the net asset value ("NAV") of a mutual fund and an offshore fund from 1996 to 1998. Whitehead caused the funds to purchase securities underwritten by a broker-dealer. After the securities began performing poorly and the issuers suffered severe financial problems, Whitehead and the broker-dealer concealed the problems from the funds and their investment advisers and inflated the value of the troubled securities, which caused one of the funds materially to overstate its NAV.
B. RESPONDENT
Whitehead, a resident of Glendale, California, was employed by a registered investment adviser as a portfolio manager from September 1993 until she resigned in November 1998. Until she resigned in November 1998, Whitehead was the portfolio manager for the Legg Mason High Yield Portfolio from its inception in February 1994 and the U.S. High Yield Investments, N.V. from its inception in March 1996.
C. RELATED PARTIES AND PERSON
Legg Mason High Yield Portfolio (the "High Yield Fund") is a series offered through Legg Mason Income Trust, Inc., an open-end investment company registered with the Commission since 1987 (File No. 811-0529). The High Yield Fund began operations in 1994. The High Yield Fund has an investment objective of providing a high level of current income and capital appreciation, had assets of $431 million as of May 31, 1998, and $218 million as of December 31, 2000, and invests its assets in high yield, fixed income securities.
U.S. High Yield Investments, N.V. (the "Offshore Fund") is part of a family of Legg Mason offshore funds. Established in 1996 as a limited liability company under Netherlands Antilles law, the Offshore Fund is available only to foreign investors. Its investment objective is to provide a high level of current income by investing primarily in high-yielding debt obligations of U.S. issuers. It had assets of $259 million as of February 28, 1998, and $159 million as of February 29, 2000.
The manager (hereinafter referred to as the "Manager") has been registered with the Commission as an investment adviser since 1982. The Manager is the manager of the High Yield Fund and the Offshore Fund (collectively the "Funds"). The Manager delegates the advisory duties to another investment adviser.
The investment adviser (hereinafter referred to as the "Investment Adviser") has been registered with the Commission as an investment adviser since 1971. The Investment Adviser is the sub-adviser for the Funds.
The broker-dealer (hereinafter referred to as the "Broker-Dealer") was registered with the Commission as a broker-dealer from July 1994 until March 2001.
D. RESPONDENT'S PURCHASE AND PRICING OF THE NOTES
1. Respondent's Purchase of Notes from the Broker-Dealer for the Funds
From July 1994 through April 1998, Respondent caused the Funds to purchase from the Broker-Dealer over $34 million in notes-$30.2 million in notes, at a purchase price of $27.9 million, for the High Yield Fund, and $4.1 million in notes at par for the Offshore Fund. Respondent caused the Funds to purchase the notes through private placements, and the High Yield Fund, either alone or with the Offshore Fund, purchased all of the notes issued in the private placements.
2. Respondent's Participation in the Pricing of Notes Held by the Funds
a. The Pricing Procedures
To calculate NAV, the Funds' securities were priced daily. For publicly traded securities, the Funds used a service to price the securities. For securities that the service could not price, Respondent was to obtain bid and ask quotes from two brokers. For the notes sold by the Broker-Dealer, Respondent could not obtain two broker quotes because the notes were not traded. Instead, Respondent, in discussions with a principal of the Broker-Dealer, set the prices for the notes.
Beginning in 1995, Respondent had the Broker-Dealer send to the Funds' accountants the prices for securities held by the Funds that the service could not price. On a daily basis, Respondent called an analyst at the Broker-Dealer with price quotes, including fictional price quotes for the notes sold by the Broker-Dealer. The Broker-Dealer analyst entered each quote on a spreadsheet as two bid and ask quotes for each security, including the notes sold by the Broker-Dealer in which the price quotes came from discussions between Respondent and the Broker-Dealer principal and not from two brokers. The Broker-Dealer then faxed the spreadsheet to the Funds' accountants.
In March 1997, Respondent was asked by the Manager to get a written statement from the Broker-Dealer describing how it obtained prices. Respondent forwarded this request to the Broker-Dealer principal. In a letter dated March 14, 1997, the Broker-Dealer responded that it "provides daily pricing for the [Funds.] Securities in each fund are priced in the following manner. Bid-ask quotations are solicited from at least two broker-dealers that trade the security. The mean of the bid prices and ask prices is then submitted for pricing purposes." In fact, Respondent and the Broker-Dealer principal priced the notes that the Broker-Dealer had sold to the Funds themselves and did not obtain quotes from two broker-dealers. Although she knew that the Broker-Dealer had not accurately described the method for pricing used for the notes sold by the Broker-Dealer, Respondent forwarded the Broker-Dealer's letter to the Manager and the Investment Adviser.
b. The Issuers' Financial Troubles, the Roll Up Transactions and the Inflated Pricing
Five of the issuers, from which Respondent purchased a total of $15.7 million par value notes for the High Yield Fund, had severe financial trouble from 1996 through 1998. These financial problems resulted in the issuers' defaulting on interest payments, being forced into involuntary bankruptcy, and/or having all their assets taken away in foreclosure proceedings. Whitehead knew of these financial problems.
In early 1997, Respondent and the Broker-Dealer principal proposed a roll up transaction in which the five problem notes would be contributed to a newly formed company controlled by the Broker-Dealer principal in exchange for notes and other securities issued by the company. Respondent and the Broker-Dealer principal were told by the Manager and its parent company's legal counsel that Respondent and the Broker-Dealer principal could not proceed with the roll up transaction without first consulting with the parent company of the Manager and its legal counsel.
In 1997 and 1998, without consulting with the Manager's parent company or its legal counsel, Respondent and the Broker-Dealer principal rolled up the troubled notes into two newly formed companies controlled by the Broker-Dealer principal. In these roll up transactions, Respondent caused the Funds to purchase from the Broker-Dealer $8.5 million in notes ($6 million for the High Yield Fund and $2.5 million for the Offshore Fund) issued by one of the newly formed companies and $5.6 million in notes ($4 million for the High Yield Fund and $1.6 million for the Offshore Fund) issued by the other company. The Broker-Dealer principal then had the first company use a portion of the $8.5 million proceeds to purchase three of the High Yield Fund's problem notes and had the second company use a portion of the $5.6 million proceeds to purchase two other of the High Yield Fund's problem notes. The Broker-Dealer principal then had the companies lend the remaining offering proceeds, a total of $1.62 million, to the Broker-Dealer's parent company. Unlike the original problem notes in which interest was due quarterly, the notes issued by the companies paid interest only at maturity. Following the roll up transactions, the Broker-Dealer principal managed the shell companies and their assets (i.e., the problem notes purchased from the High Yield Fund).
Respondent and the Broker-Dealer principal's pricing of the five problem notes and, subsequent to the roll up transactions, their pricing of the newly formed companies' notes failed to reflect the notes' performance and the original issuers' financial condition and overstated the value of the notes. From August 30, 1996, through November 30, 1998, the problem notes and the companies' notes were overstated by amounts ranging from $1.625 million to $3.705 million. As a result of this inflated pricing, the High Yield Fund had materially overstated NAV. The inflated pricing was a direct result of the pricing procedures designed and implemented by Respondent and the Broker-Dealer principal. In particular, by one reasonable measure, the High Yield Fund's NAV was overstated from August 30, 1996, through November 30, 1998, by amounts ranging from $.09 (or .52% of NAV) to $.20 (or 1.33% of NAV).
E. RESPONDENT'S VIOLATIONS OF THE FEDERAL SECURITIES LAWS
1. Antifraud Violations: Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 Thereunder and Sections 206(1) and (2) of the Advisers Act
Section 17(a) of the Securities Act prohibits fraud in the offer and sale of securities, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit fraud in connection with the purchase or sale of any security. Sections 206(1) and (2) of the Advisers Act prohibit fraud by an investment adviser upon any client or prospective client.
Respondent willfully violated the antifraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by: misrepresenting and omitting to disclose information regarding the issuers' financial problems; pricing the problem notes and the newly formed companies' notes at inflated values; and engaging in the roll up transactions. As a result of this conduct, Respondent was also a cause of, and willfully aided and abetted, violations of the antifraud provisions of Sections 206(1) and (2) of the Advisers Act.
2. NAV Violations: Rule 22c-1(a) of the Investment Company Act
Rule 22c-1(a), promulgated pursuant to Section 22(c) of the Investment Company Act, prohibits investment companies issuing redeemable securities from selling, redeeming or repurchasing any fund shares except at a price based on the current NAV. Under Section 2(a)(41) of the Investment Company Act and Rule 2a-4 thereunder, current NAV calculations must be based on current market value or, if market quotations are not readily available, fair value as determined in good faith by the board of directors. As a result of her conduct in pricing the problem notes and the newly formed companies' notes, Whitehead was a cause of, and willfully aided and abetted, violations of Rule 22c-1(a).
3. Books and Records Violations: Section 34(b) of the Investment Company Act
Section 34(b) of the Investment Company Act prohibits any person from making any untrue statement of a material fact or omitting to state any material fact in any registration statement, application, report, account, record or other document required to be filed or transmitted pursuant to the Investment Company Act or keeping of which is required pursuant to Section 31(a) of the Investment Company Act. Section 31(a) of the Investment Company Act and Rule 31a-1(a) thereunder require registered investment companies to maintain and keep current the accounts, books and other documents that constitute the record forming the basis for their financial statements required to be filed pursuant to Section 30 of the Investment Company Act.
Respondent willfully violated Section 34(b) of the Investment Company Act by submitting false prices for the notes, which prices were included in the High Yield Fund's NAV calculations and constituted records forming the basis for the High Yield Fund's financial statements.
Respondent also was a cause of, and willfully aided and abetted violations of Section 34(b) of the Investment Company Act. The High Yield Fund's 1995 through 1998 offering documents, which were annually filed and transmitted pursuant to the Investment Company Act, falsely represented that securities with no readily available market quotations were valued either by obtaining prices from recognized broker-dealers in the same or similar securities by the fund's board. In fact, at the time that the High Yield Fund's offering documents were filed, Respondent and the Broker-Dealer valued the notes, which had no readily available market quotations, at inflated prices. Respondent had actual knowledge of the violation and her role in it and substantially assisted in the violation. She, as the portfolio manager, knew or was reckless in not knowing the Funds' pricing representations. She also knew that the notes had no readily available market quotations and that she and the Broker-Dealer were pricing the notes at an inflated value and not at values determined by two broker-dealers or the fund's managing director and supervisory board.
IV.
Based on the foregoing, the Commission deems it appropriate in the public interest to accept the Offer submitted by Whitehead and impose the sanctions specified in the Offer.
Accordingly, IT IS HEREBY ORDERED that Whitehead shall cease and desist from committing or causing any violation and any future violation of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, Sections 206(1) and (2) of the Advisers Act and Section 34(b) of the Investment Company Act and shall cease and desist from causing any violation and any future violation of Rule 22c-1(a) under the Investment Company Act.
IT IS FURTHER ORDERED that Whitehead shall, within thirty (30) days of the entry of this Order, pay a civil money penalty in the amount of $25,000 to the United States Treasury. Such payment shall be: (A) made by United States postal money order, certified check, bank cashier's check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Alexandria, VA 22312-0003; and (D) submitted under cover letter that identifies Whitehead as the Respondent and the file number of this proceeding, a copy of which cover letter and money order or check shall be sent to Sandra J. Harris, Associate Regional Director, Pacific Regional Office, Securities and Exchange Commission, 5670 Wilshire Blvd., 11th Floor, Los Angeles, CA 90036.
IT IS FURTHER ORDERED that Whitehead is barred from association with any investment adviser and is prohibited from serving or acting as an employee, officer, director, member of advisory board, investment adviser or depositor of, or principal underwriter for, a registered investment company or affiliated person of such investment adviser, depositor or principal underwriter.
By the Commission.
Jonathan G. Katz
Secretary