UNITED STATES OF AMERICA
|In the Matter of
SEAN P. BRENNAN, and
|ORDER MAKING FINDINGS, IMPOSING
REMEDIAL SANCTIONS AND
WALSH TO CEASE AND DESIST
PURSUANT TO SECTION 8A OF THE
SECURITIES ACT OF 1933, SECTIONS
15(b)(6) AND 21C OF THE SECURITIES
EXCHANGE ACT OF 1934, SECTIONS
203(f) AND 203(k)(1) OF THE
INVESTMENT ADVISORS ACT OF 1940,
AND SECTION 9(b) OF THE
INVESTMENT COMPANY ACT OF1940
On September 23, 1998, the Securities and Exchange Commission ("Commission") instituted these administrative proceedings 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"), Sections 203(f) and 203(k)(1) of the Investment Advisers Act of 1940 ("Advisers Act") and Section 9(b) of the Investment Company Act of 1940 ("Investment Company Act").
Respondent Keith E. Walsh has submitted an Offer of Settlement that the Commission has determined to accept. Solely for the purposes of these proceedings and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, and prior to hearing and without admitting or denying the findings set forth herein, Walsh consents to the entry of this Order Making Findings, Imposing Remedial Sanctions and Ordering Respondent Walsh to Cease and Desist Pursuant to Section 8A of the Securities Act of 1933, Sections 15(b)(6) and 21C of the Securities Exchange Act of 1934, Sections 203(f) and 203(k)(1) of the Investment Advisers Act of 1940, and Section 9(b) of the Investment Company Act of 1940 ("Order"). The Commission has determined that it is appropriate and in the public interest to accept the Offer of Settlement from Walsh, and accordingly is issuing this Order.
Based on the foregoing, the Commission finds that:1
Keith E. Walsh, age 41, resides in Phoenixville, Pennsylvania. From August 3, 1992 until May 11, 1994, Walsh was employed by CS First Boston Investment Management Corporation ("CSFBMIC") as Vice President, Portfolio Management, Short-Term Fixed Income. CSFBMIC was registered with the Commission as an investment adviser under the Advisers Act during this period, and was an affiliate of CS First Boston ("First Boston"), a registered broker-dealer. From December 1993 until May 1994, CSFBIMC was the investment adviser for the CS First Boston Offshore Cash Reserve Fund ("Offshore Fund" or the "Fund"), a now defunct investment company that was incorporated under the laws of the Cayman Islands.
Walsh's responsibilities at CSFBIMC included managing the investment portfolio of the Offshore Fund. Walsh also oversaw the management of the short-term fixed income investment group with responsibility for more than $6 billion of managed assets, worked directly with CSFBIMC's marketing group on matters concerning his areas of responsibility, and oversaw CSFBIMC's credit function. This proceeding involves Walsh's activities2 in connection with the Offshore Fund, which was launched in January 1994 and was liquidated by the end of March 1994.
B. The Formation Of The Offshore Fund
During the Fall of 1993, CSFBIMC made plans to create, develop and market an unregistered offshore fund, eventually entitled the "CS First Boston Offshore Cash Reserve Fund," designed for sophisticated institutional investors. Unlike a traditional money market fund subject to Rule 2a-7 under the Investment Company Act of 1940, the original concept of the Fund was to be an offshore, near money market fund with an enhanced yield, which would be obtained by investing in instruments with a longer weighted average maturity than the 90-day weighted average maturity required for Rule 2a-7 money market funds. CSFBIMC's internal plan, designed by Walsh, was to have the Fund's securities portfolio consist of approximately 70% money market instruments and 30% securities with an average duration of approximately two years, with most of the longer-term portion of the portfolio invested in structured rate notes ("SRNs")3.
The Fund was launched on December 15, 1993 with the issuance by CSFBIMC of an offering circular for shares of the Fund. The initial offering circular (the first of three for the Fund) did not contain any disclosure about investments in SRNs, but disclosed the following investment objective: "The Fund's investment objective is to seek a high level of current income, consistent with the preservation of capital and the maintenance of liquidity through investment principally in money market instruments and fixed income securities."4
The initial offering circular also contained the following disclosure to notify investors that the Fund's NAV may fluctuate:
The Net Asset Value per share will fluctuate with the value of the Fund's investments, although the Fund will normally attempt to maintain a Net Asset Value per share that when rounded to the nearest whole cent will equal $1.00. However, the Fund is not a U.S. registered money market fund and is not subject to Rule 2a-7 under the U.S. Investment Company Act of 1940, and there can be no assurance that its rounded Net Asset Value will be stable.
C. The Fund's Portfolio
Beginning in December 1993, Walsh embarked on an investment strategy that was inconsistent with the Fund's offering circular and investment policies. Rather than use the Fund's initial $300 million to build a portfolio similar to the 70/30 model portfolio, Walsh used virtually all of the money to buy SRNs.5 In addition, using reverse repurchase agreements, Walsh leveraged the Fund to buy additional SRNs. By January 27, 1994, the Fund was leveraged by $255 million, and the SRNs and other longer duration securities totaled $451 million (or approximately 150% of the Fund's contributed capital). During February 1994, approximately 58% of the Fund's net assets was invested in SRNs.
D. The Misleading Marketing Materials
Walsh also created charts and graphs that were misleading withrespect to the contents and composition of the Fund. For example, to assist the Fund's salespeople, Walsh created a portfolio chart, dated January 4, 1994, purportedly listing the Fund's investments. The portfolio chart was incomplete in that it included only approximately $305 million of the total $425 million of investments in the portfolio as of that date. The chart excluded $100 million of SRNs and did not reflect the leverage in the portfolio. The chart was also misleading because it miscalculated the weighted average maturity of the portfolio by understating the number of days to maturity for some of the SRNs.
A portfolio composition pie chart derived from the portfolio composition chart was also incomplete and misleading because it omitted to list $100 million of SRNs and the existence of leverage in the portfolio as of that time. Walsh used the pie chart to explain the Fund's portfolio to CSFBIMC's salespeople. Walsh also knew that the pie chart would be used by the salespeople in connection with their efforts to market the Fund.
E. Mispricing of the SRNs
In December 1993, CSFBIMC hired an administrator for the Offshore Fund. However, because the administrator did not have the ability to price the SRNs owned by the Fund, CSFBIMC decided that Walsh would be responsible for doing so. Although the offering circular represented that the securities would be priced by independent dealers, many of the prices were ultimately determined by Walsh without the aid of any independent pricing mechanism.
On January 10, 1994, the administrator notified Walsh that the prices that Walsh had provided to them resulted in an NAV that was less than $1.00 per share. Without consulting his supervisors or anyone else at CSFBIMC, Walsh told the administrator to change the prices of four of the SRNs, which resulted in a recalculated NAV of $1.00.
Walsh encountered difficulties obtaining prices from independent dealers, and eventually stopped calling independent dealers to get price quotes for the SRNs. Instead, Walsh began providing the administrator with his own estimates of their values. On February 4, 1994, after approximately three years of generally declining rates, the Federal Reserve increased the Fed Funds rate from 3% to 3.25%. This action by the Federal Reserve caused a general climb in United States and world interest rates during February 1994, and those increases caused a decline in the value of the Fund's portfolio. However, Walsh's price estimates for the SRNs changed very little from day to day, even though the bond market was in turmoil. The decline in the value of the Fund's portfolio was not reflected in the Fund's NAV due to the improper price estimates supplied by Walsh.
On February 24, 1994 one of Walsh's colleagues noticed a pricing discrepancy in the Fund's portfolio spreadsheet. CSFBIMC then reassigned the pricing responsibility to another employee, who obtained price indications for all of the Fund's securities on March 2, 1994. At that time the portfolio was valued at an NAV of $.9727, or a net loss of approximately $24 million.
Section 17(a) of the Securities Act makes it unlawful, in the offer or sale of securities, (1) to employ any device, scheme or artifice to defraud, or (2) to obtain money or property by means of any untrue statement of material fact or any omission to state a material fact necessary to make the statements made, in light of the circumstances in which they were made, not misleading, or (3) to engage in any transaction, practice, or course of business that operates as a fraud or deceit upon a purchaser. Section 10(b) of the Exchange Act and Rule 10b-5 thereunder make it unlawful to employ any device, scheme or artifice to defraud in connection with the purchase or sale of securities. Section 206(1) of the Advisers Act makes it unlawful for an investment adviser to employ any device, scheme or artifice to defraud any client or prospective client. Section 206(2) makes it unlawful for an investment adviser to engage in any transaction, practice, or course of business that operates as a fraud or deceit upon any client. CSFBIMC violated each of the foregoing provisions.
Beginning in December 1993, Walsh began purchasing SRNs contrary to the Fund's stated investment objectives and policies; by February 1994, approximately 58% of the Fund's net assets were invested in SRNs. Walsh also provided prices for the SRNs himself, rather than relying upon prices from independent dealers as was represented by the Fund's offering circulars. Finally, Walsh prepared or facilitated the preparation of various marketing materials that failed to accurately represent the composition of the Fund's portfolio and misrepresented the weighted average maturity of the portfolio. Accordingly, Walsh willfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and caused and willfully aided and abetted CSFBIMC's violations of Section 206 of the Advisers Act.
Based on the above, the Commission finds that Walsh:
A. willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and caused and willfully aided and abetted violations of Sections 206(1) and 206(2) of the Advisers Act, and
B. has submitted a sworn financial statement and other evidence and has asserted his financial inability to pay a civil penalty. The Commission has reviewed the sworn financial statement and other evidence provided by Walsh and has determined that Walsh does not have the financial ability to pay a civil penalty.
Accordingly, IT IS HEREBY ORDERED that,
A. Walsh is barred from association with any broker, dealer, investment adviser or investment company 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;
B. Walsh cease and desist from committing or causing any violations of, and committing or causing any future violations of, Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Advisers Act, and
C. the Division of Enforcement ("Division") may at any time following the entry of this Order, petition the Commission to: (1) reopen this matter to consider whether Walsh provided accurate and complete financial information at the time such representations were made; (2) determine the amount of the civil penalty to be imposed; and (3) seek any additional remedies that the Commission would be authorized to impose in this proceeding if Walsh's Offer had not been accepted. No other issues shall be considered in connection with this petition other than whether the financial information provided by Walsh was fraudulent, misleading, inaccurate or incomplete in any material respect, the amount of civil penalty to be imposed and whether any additional remedies should be imposed. Walsh may not, by way of defense to any such petition, contest the findings in this Order or the Commission's authority to impose any additional remedies that were available in the original proceeding.
By the Commission.
Jonathan G. Katz
|1||The findings herein are made pursuant to Walsh's Offer of Settlement and are not binding on any other person or entity in this or any other proceeding.|
|2||Orders making findings, imposing remedial sanctions and cease-and-desist orders were also entered on consent in related administrative proceedings concerning CSFBIMC, Sean P. Brennan and Nicholas C. Bogard. Brennan was the Vice President of Sales and Marketing for the Investment Management Group of CSFBIMC, and was responsible for selling the Offshore Fund to institutional investors. Bogard was the Director of Mutual Fund Sales at CSFBIMC, and was Brennan's supervisor. See CS First Boston Investment Management Corporation, Securities Act of 1933 Release No. 7583 (Sept. 23, 1998); Sean P. Brennan, Securities Act Release No. 7619 (Dec. 23, 1998); Nicholas C. Bogard, Securities Exchange Act Release No. 40467 (Sept. 23, 1998).|
|3||SRNs are over-the-counter securities, the terms of which are negotiated by the dealer (usually a bank or securities firm) and the purchaser. SRNs generally commit the dealer to provide a return linked to one or more desired interest rates, indices, currencies or other assets. While the payment of principal and interest to the purchaser is typically guaranteed by the dealer, the amount of such payments can fluctuate, depending on the terms of the SRN. SRN's can be, and in this case were, volatile derivative securities.|
|4||The second offering circular, dated January 24, 1994, disclosed that the Fund could invest in SRNs, including inversely indexed floating rate notes, as an additional investment strategy, but failed to disclose the degree of risk to which the Fund was exposed as a result of the Fund's significant position in these securities.|
|5||The SRNs purchased by Walsh, most of which were linked to one or more foreign interest rates, were dollar denominated and principally protected (i.e., the dealers were obligated to repay the par amount of the SRNs at maturity). However, many of the SRNs were inverse floaters that had coupon rates that could reset to zero if the interest rate or rates to which they were linked rose above certain predetermined levels. As set forth below, United States and world interest rates increased rapidly during early 1994, causing a substantial decline in the value of the SRNs purchased by Walsh.|
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