UNITED STATES OF AMERICA
In the Matter of
KYLE R. KIRKLAND, Respondent.
|ORDER INSTITUTING PUBLIC |
MAKING FINDINGS AND IMPOSING
SANCTIONS AND CEASE-AND-DESIST
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"), Sections 15(b)(6) and 21C of the Securities Exchange Act of 1934 ("Exchange Act"), Section 203(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 Kyle R. Kirkland ("Kirkland" or "Respondent").
In anticipation of the institution of this administrative proceeding, Kirkland 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 Kirkland admits the jurisdiction of the Commission over him and over the subject matter of this proceeding, Kirkland 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, Sections 15(b)(6) and 21C of the Exchange Act, Section 203(k) of the Advisers Act and Sections 9(b) and (f) of the Investment Company Act be, and hereby is, instituted.
On the basis of this Order and Kirkland's Offer, the Commission finds that:
This matter involves a portfolio manager and Kirkland, a principal of a former broker-dealer 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. The portfolio manager caused the funds to purchase securities underwritten by the broker-dealer and Kirkland. After the securities began performing poorly and the issuers suffered severe financial problems, Kirkland provided information as to the value of certain securities without disclosing that the valuations did not reflect the current market value of the securities. Kirkland participated with the portfolio manager in providing valuations for the troubled securities that did not reflect current market value, which caused the one of the funds to materially overstate its NAV.
Kirkland, a resident of Los Angeles, California, was a registered representative from 1988 through January 2001 and held Series 7, 24, 27 and 63 licenses until January 2001. Kirkland was a principal officer and director of a broker-dealer until the broker-dealer ceased operations in August 1999 and withdrew its registration in 2001.
C. RELATED ENTITIES AND PERSON
1. The broker-dealer (hereinafter referred to as the "Broker-Dealer") was registered with the Commission as a broker-dealer from July 1994 until it ceased operations in August 1999 and withdrew its registration effective March 2001. The Broker-Dealer was an investment banking firm specializing in restructurings and private placements for institutional clients.
2. 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.
3. 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.
4. 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 investment adviser for the High Yield Fund and Offshore Fund (collectively, the "Funds").
5. The portfolio manager (hereinafter referred to as the "Portfolio Manager") was employed by the Investment Adviser and was the Funds' portfolio manager until she resigned in November 1998.
D. THE SALE AND PRICING OF THE NOTES BY KIRKLAND AND THE PORTFOLIO MANAGER
1. The Sale of Notes to the Funds
From July 1994 through April 1998, Kirkland participated in the sale to the Funds of over $34 million in notes-$30.2 million in notes, at a purchase price of $27.9 million, to the High Yield Fund, and $4.1 million in notes at par to the Offshore Fund. Kirkland participated in the sale of the notes through private placements, and the notes were held by either the High Yield Fund alone or with the Offshore Fund.
2. Kirkland'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, the Portfolio Manager was to obtain bid and ask quotes from two brokers. For the notes sold by the Broker-Dealer, the Portfolio Manager could not obtain two broker quotes because the notes were not traded. Instead, the Portfolio Manager, in discussions with Kirkland, set the price quotes for the notes.
Beginning in 1995, the Broker-Dealer, with Kirkland's consent, became involved in sending to the Funds' accountants the prices for securities held by the Funds that the service could not price. On a daily basis, the Portfolio Manager called one of the Broker-Dealer's analysts with price quotes. The Broker-Dealer analyst entered each quote on a spreadsheet as two bid and ask price quotes for each security, including the notes sold by the Broker-Dealer in which the price quotes came from discussions between Kirkland and the Portfolio Manager and not from two brokers. The Broker-Dealer then faxed the spreadsheet to the Funds' accountants.
In a letter dated March 14, 1997, Kirkland misrepresented to the Funds and the Investment Adviser the methodology they used in pricing the Funds' securities. In the letter, Kirkland stated that the Broker-Dealer "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, Kirkland and the Portfolio Manager priced the notes that the Broker-Dealer had sold to the Funds themselves and did not obtain quotes from two broker-dealers.
b. The Issuers' Financial Troubles, the Roll Up Transactions and Kirkland's Participation in the Pricing
Five of the issuers, for which Kirkland participated in the sale of a total of $15.7 million par value notes to the High Yield Fund, had financial trouble at various points 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. Kirkland and the Portfolio Manager knew of these financial problems.
In early 1997, Kirkland and the Portfolio Manager proposed a roll up transaction in which the five notes would be contributed to a newly formed company controlled by Kirkland in exchange for notes and other securities issued by the newly formed company. Kirkland and the Portfolio Manager were specifically told that they could not proceed with the roll up transaction without first consulting with the parent company of the Investment Adviser and its legal counsel.
In 1997 and 1998, without consulting with the Investment Adviser's parent company or its legal counsel, Kirkland and the Portfolio Manager rolled up the troubled notes into two newly formed companies controlled by Kirkland. In these roll up transactions, the Broker-Dealer, with the participation of Kirkland, sold to the Funds $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 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. Kirkland then had the first company use a portion of the $8.5 million proceeds to purchase from the 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. Kirkland 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 permitted interest to be paid in kind and therefore, at maturity. Following the roll up transactions, Kirkland managed the companies and their assets (i.e., the problem notes purchased from the High Yield Fund).
Kirkland's and the Portfolio Manager's pricing of the five problem notes and, subsequent to the roll up transactions, their pricing of the companies' notes failed to reflect the underlying notes' performance and the original issuers' financial condition and overstated the value of the notes. From August 30, 1996, through November 30, 1998, Kirkland and the Portfolio Manager overvalued the problem notes and the companies' notes by amounts ranging from $1.625 million to $3.705 million. As a result of this inflated pricing, Kirkland and the Portfolio Manager caused the High Yield Fund materially to overstate its NAV. 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.
As a result of his conduct in pricing the problem notes and the companies' notes at inflated value and engaging in the roll up transactions, Kirkland 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. Kirkland also was 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 his conduct in pricing the problem notes and the companies' notes, Kirkland 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 to omit 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.
Kirkland was a cause of, and willfully aided and abetted, violations of Section 34(b) of the Investment Company Act by submitting to the High Yield Fund's accountants 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.
Based on the foregoing, the Commission deems it appropriate in the public interest to accept the Offer submitted by Kirkland and impose the sanctions specified in the Offer.
Accordingly, IT IS HEREBY ORDERED that Kirkland 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 Kirkland shall, within thirty (30) days of the entry of this Order, pay a civil money penalty in the amount of $30,000 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 Kirkland 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 Kirkland is barred from association with any broker or dealer with the right to reapply for association after three (3) years to the appropriate self-regulatory organization, or if there is none, to the Commission, 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, with the right to reapply for service in any such capacity with the Commission after three (3) years from the date of the Order.
By the Commission.
Jonathan G. Katz
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