U.S. SECURITIES AND EXCHANGE COMMISSION
Litigaton Release No. 18505 / December 12, 2003
SECURITIES AND EXCHANGE COMMISSION V. HEARTLAND ADVISORS et al., (United States District Court for the Eastern District of Wisconsin) 03 C-1427
CIVIL INJUNCTIVE ACTION FILED AGAINST HEARTLAND ADVISORS AND CERTAIN EMPLOYEES FOR MISREPRESENTATIONS AND OMISSIONS, MISPRICING OF BONDS IN TWO MUTUAL FUNDS AND INSIDER TRADING IN THESE SAME FUNDS
The SEC announced that it filed a civil injunctive action in the Eastern District of Wisconsin against Heartland Advisors Inc. ("Heartland Advisors"), William Nasgovitz, Paul Beste, Jilaine Bauer, Thomas Conlin, Greg Winston, Kevin Clerk, Kenneth Della, Hugh Denison and Raymond Krueger. In its complaint, the SEC alleges that Heartland Advisors, through Nasgovitz, Beste, Bauer, Clark, Conlin and Winston misrepresented the NAVs of two high yield municipal bond funds, the Heartland Short Duration High-Yield Municipal Bond Fund and the Heartland High-Yield Municipal Bond Fund (the "Funds) and, in Commission filings and promotional materials, their efforts to manage certain risks associated with investing in the Funds. For example, Heartland Advisors represented that it was actively managing the Funds to minimize share price fluctuation when it was not doing so. Heartland Advisors also represented that it performed intensive credit research and limited the percentage of unrated high yield bonds held by funds. In reality, Heartland Advisors conducted inadequate research and the vast majority of bonds held by the Funds were unrated and relatively illiquid. Finally, Heartland Advisors misrepresented that it and the Funds' Board of Directors would monitor and maintain sufficient liquidity in the Funds' portfolio holdings to assure that the Funds would be able to meet redemptions. They did not do so. Instead the Funds had to borrow millions to meet redemptions. As a result, by mid-2000, the Funds were suffering a cash flow crisis.
The SEC also alleges that the root of this problem was that Heartland Advisors, through Nasgovitz, Conlin, Winston, Beste, Bauer, Clark and Della, in order to protect the Funds' performance, refused or failed to adjust the prices of the Funds' securities despite numerous indications that the bonds held by the Funds could only be sold at substantial discounts to their carrying values. Heartland Advisors later arranged a purported "sale" of those bonds that, in reality, more closely resembled a short-term loan to temporarily infuse cash into the Funds. Nevertheless, the substantially discounted "sale" prices of those bonds caused the Funds' NAVs to drop materially on Sept. 28, 2000 (the September Devaluation). Thereafter, Heartland Advisors misrepresented to investors the cause of the September Devaluation. Faced with continuing redemptions and consequent cash flow problems, which caused it to consider suspending redemptions, on October 13, Heartland Advisors repriced most of the bonds in the Funds' portfolios by taking an across-the-board discount. This resulted in another substantial drop in the Funds' NAVs (the October Devaluation). Again, Heartland Advisors misrepresented the real reason for this drop in the Funds' NAVs. The complaint alleges that Denison, an associated Director of the Funds failed to adequately monitor the liquidity of the Funds and to take adequate steps to address the Funds' pricing deficiencies.
Finally, the SEC alleges that while investors were kept unaware of the Funds' problems, Nasgovitz tipped Krueger about the Funds' continuing liquidity and/or pricing problems prior to the September Devaluation, and Krueger liquidated his shares in one of the Funds. In addition, with knowledge of the Funds' continuing liquidity and pricing problems: Winston, a portfolio manager of the Funds, liquidated his shares in the Funds and tipped his family to liquidate their shares in one or more of the Funds, or a related fund; Bauer liquidated her shares in one of the Funds; and Della liquidated his shares in the Funds and redeemed his father's shares in a related fund.
The SEC charged: Heartland Advisors with violations of Section 17(a) of the Securities Act of 1933 (Securities Act) and Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5 thereunder, Section 206 of the Investment Advisers Act of 1940 (Advisers Act), Sections 34(b) and 36(a) of the Investment Company Act of 1940 (Investment Company Act) and Rule 22c-1(a) promulgated thereunder; Nasgovitz, Conlin, Winston, Beste, Bauer, and Clark with violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Sections 34(b) and 36(a) of the Investment Company Act, and aiding and abetting violations of Section 206 of the Advisers Act; Della with violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Section 36(a) of the Investment Company Act and aiding and abetting violations of Section 206 of the Advisers Act; Krueger with violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; and Denison with violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act and Section 36(a) of the Investment Company Act. The SEC seeks an order of permanent injunction, disgorgement plus pre-judgment interest of the defendants' ill-gotten gains, including insider trading losses avoided from those defendants charged with insider trading, and civil penalties from all of the defendants for their violations.