Securities and Exchange Commission
In the Matter of
PIPER CAPITAL MANAGEMENT, INC.,
OPINION OF THE COMMISSION
INVESTMENT ADVISER PROCEEDING
INVESTMENT COMPANY PROCEEDING
Grounds for Remedial Action
Violations of Disclosure Requirements
Fraudulent Pricing of Net Asset Value
Accounts and Records Violations
Falsification of Reports
Aiding, Abetting, and Causing Unlawful Change of Investment Policy
Registered investment adviser and associated person made fraudulent statements and omitted material facts in connection with the offer and sale of fund securities. Adviser aided, abetted, and was a cause of changes in managed fund's investment policy without shareholder approval.
Adviser and associated persons fraudulently priced managed fund's net asset value, placed false information on the fund's daily reports, and willfully aided and abetted and were causes of that fund's selling, purchasing, and redeeming shares at prices that were not based on the fund's current net asset value, and fund's failure to maintain appropriate books and records.
Held, it is in the public interest to revoke the investment adviser's registration; order the investment adviser to pay a civil money penalty of $2,005,000; censure respondents; and order respondents to cease and desist from committing or causing violations or future violations of the provisions that they were found to have violated.
Lawrence J. Field and Todd A. Noteboom, of Leonard, Street, and Deinard, for Piper Capital Management, Inc.
Philip M. Goldberg and Lisa L. Tharpe, of Foley & Lardner, and Todd A. Strother, of Bradshaw, Fowler, Proctor & Fairgrave, for Marijo A. Goldstein.
Robert J. Hennessey and Eric J. Peck, of Lindquist & Vennum, P.L.L.P., for Robert H. Nelson.
Stephen P. Bedell and Scott M. Murray, of Gardner, Carton & Douglas, for Amy K. Johnson.
Jodeen A. Kozlak and Andrew M. Luger, of Greene Espel, P.L.L.P., for Molly J. Destro.
Gregory P. Von Schaumburg, Randall J. Fons, and Thomas W. Szromba, for the Division of Enforcement.
Appeal filed: December 22, 2000
Last brief received: November 1, 2001
Oral Argument: July 31, 2003
Piper Capital Management, Inc. ("PCM"), Marijo A. Goldstein, Robert H. Nelson, Amy K. Johnson, Molly J. Destro (collectively,the "Respondents"), and the Division of Enforcement appeal from the decision of an administrative law judge. 1 The law judge found that PCM and Goldstein violated Section 17(a) of the Securities Act of 1933, 2 Section 10(b) of the Securities Exchange Act of 1934, 3 Exchange Act Rule 10b-5, 4 and Section 34(b) of the Investment Company Act of 1940 5 by making in various disclosure documents misrepresentations or omissions of material fact relating to the risks associated with an investment in a mutual fund PCM managed. PCM also caused that fund's violations of IC Act Section 13(a)(3) 6by aiding and abetting a material deviation from the fund's stated investment objective without shareholder consent. 7
The law judge found that the Respondents violated Securities Act Section 17(a), Exchange Act Section 10(b), Exchange Act Rule 10b-5, and IC Act Section 34(b), and willfully aided and abetted and werecauses of violations of IC Act Rule 22c-1 8, IC Act 31(a), 9 and IC Act Rule 31a-1, 10 by manipulating the fund's net asset value on April 4, 5, and 6, 1994.
The law judge censured Respondents and ordered each of them to cease and desist from violating or causing violations of the federal securities laws. Additionally, the law judge revoked PCM's registration as an investment adviser and assessed civil money penalties against it totaling $2,005,000. 11
The Respondents appeal the findings of violation against them and the sanctions imposed. The Division also appeals the sanctions imposed, and whether the Fund's net asset value was calculated only weekly, rather than daily, in violation of the IC Act. We base our findings on an independent review of the record, except with respect to those findings not challenged on appeal.
1. PCM. PCM registered with the Commission as an investment adviser in 1983 and was a wholly-owned subsidiary of Piper Jaffray Companies Inc. In 1998, Piper Jaffray Companies Inc. merged with U.S. Bancorp. PCM represents that, after May 1, 1998, it ceased operations.
2. Marijo Goldstein. Initially, Goldstein served as a fund analyst. In 1989, Goldstein became a "co-manager" with Worth V. Bruntjen of the Institutional Government Income Portfolio ("PJIGX," "Portfolio," or the "Fund"). In 1991, Goldstein was promoted to vice-president at PCM and became a senior vice-president in 1993. Goldstein remained a Fund co-manager through June 1994 and a PCM senior vice-president through 1995.
3. Robert H. Nelson. Nelson joined PCM in 1988 as an accountant in its operations department. Nelson became an officer of PCM in 1990 and was promoted to senior vice-president in 1993. From November 1993 to November 1997, Nelson was the manager of PCM'sMutual Fund Accounting Department and directly supervised Johnson and Destro.
4. Amy K. Johnson. Nelson hired Johnson in 1992 as operations coordinator to work with the Fund's transfer agent. Johnson, a certified public accountant, became an accounting manager in the summer of 1993 and had primary responsibility for 20 of the 38 funds managed by PCM, including PJIGX.
5. Molly J. Destro. Nelson hired Destro in 1991 as a mutual fund accountant. Prior to joining PCM, Destro had earned a bachelors degree in accounting, obtained series 7 and 63 licenses as a registered representative, and had auditing and mutual fund accounting experience. Destro had pricing responsibilities and acted as a liaison between PCM portfolio managers and pricing sources. In late 1992 or early 1993, Destro was promoted to accounting manager, and became a PCM vice-president in 1994.
6. Related Individuals.
a. Worth V. Bruntjen. Bruntjen, along with Goldstein, was a co-manager of the Fund from its inception in 1988 until his resignation from PCM in January 1998. 12
b. Marcy Winson. Winson worked for PCM from March 1993 through January 1997. Winson served as an assistant portfolio manager for the Fund. Winson was not named as a respondent in this proceeding.
To provide a context for the disclosure violations, we briefly discuss mortgage-backed securities and their valuation. Mortgage-backed securities ("MBS") are bonds backed by monthly mortgage payments of a pool of mortgage loans. A mortgage originator will collect pools of mortgages with similar coupons and maturities, and bundle the cash flow of monthly payments into MBS.
The value of an MBS is a function of its underlying cash flow. MBS cash flow includes principal, interest, and any early return of principal due to a payoff or prepayment of a mortgage in the pool. As long-term interest rates fall, mortgage rates tend to follow, and mortgage holders have a greater incentive to refinance. Prepayment rates therefore generally increase when long-term rates fall, and fall when long-term rates rise. 14 Because prepayments can be made at any time, the cash flow of an MBS is uncertain.
A collateralized mortgage obligation ("CMO") is a type of MBS. CMOs may be structured into several classes or tranches of bonds, and may have different yield and price volatility characteristics than the underlying mortgages from which they were created. 15 CMO bond classes can be created with different kinds of interest rate structures, for example, fixed, floating, or inverse floating. The interest paid to floaters is directly linked to a specified floating reference interest rate (such as the London Interbank Offered Rate). The interest paid to inverse floaters is inversely linked to a specified floating reference interest rate.
Because inverse floater coupons move in the opposite direction of the floating reference interest rate, investors generally require higher yields to compensate for the risk of price decline. In order to increase the yield, inverse floaters are often structured with "multipliers" embedded in their coupon formulas, which magnify movements in the underlying floating reference interest rate and will increase any price decline experienced by inverse floaters. Inverse floater prices can be highly volatile because they are simultaneously exposed both to prepayment risk and coupon leverage.
One measurement for valuing pass-through securities is the rate, or "speed," of prepayments. Another measurement is an instrument's "weighted average life," which is the average time that a dollar of principal is outstanding and earning interest before being returned to the security holder. Most fixed income investments pay interest at intervals and return principal at the final maturity or call date. Pass-through securities differ in that they return increments of principal over the life of the security. Therefore, because a pass-through security is subject to prepayment and extension risk, its weighted average life is computed in order to compare MBS to other fixed income securities. However, the weighted average life canchange dramatically due to a small change in interest rates or a small change in the assumptions about future prepayment rates.
The expected interest rate sensitivity for CMOs is measured in terms of duration and convexity. Duration is a generic term that describes the responsiveness of a bond's price to a change in interest rates. Duration is denominated in years. For example, in the event of a 1% increase in interest rates, a security with a duration of 15 years would be expected to experience an immediate 15% decline in its value. 16 A high duration indicates high price sensitivity to a change in interest rates, while a low duration indicates less price sensitivity. The duration of an entire portfolio is the weighted average of the duration of its individual securities.
For prepayment and interest-rate sensitive securities like CMOs, small shifts in interest rates may produce a substantial change in duration. In order to account for this, the sensitivity of a security's duration to a change in interest rates is measured by "convexity." A security with "negative convexity" will experience a decrease in duration as interest rates decline, and an increase in duration as interest rates rise. Most MBS exhibit negative convexity because mortgage borrowers tend to prepay their mortgages when interest rates decline. These prepayments shorten the average lives of the underlying mortgages and decrease the durations of the securities.
Some formulations of duration, including "implied" and "modified" duration, have limited use in assessing interest-rate sensitive CMOs. Modified duration assumes that the cash flows from a bond remains unchanged when interest rates change. Implied duration is a measure that accounts for the historical correlation between the bond price and interest rates. Implied duration is not a forward-looking measure. In order to overcome these shortcomings, analysts developed "effective duration," which employs computer simulation techniques to project a security's cash flows along a large number of possible interest rate paths.
In 1988, the Piper Jaffray Investment Trust, Inc., an open-end, diversified management investment company, began offering the Fund toinvestors. 17 PCM was the Fund's investment adviser. Bruntjen and Goldstein had a substantive role in the preparation of various publically-disseminated Fund disclosure documents and marketing materials. Bruntjen testified that Goldstein, who was knowledgeable about duration, had final and equal editorial authority over the contents of these documents.
The Fund had a stated investment objective of "a high level of current income consistent with preservation of capital." The Fund stated that it would invest "exclusively in short/inter-mediate fixed income securities issued by the U.S. Government or governmental agencies or instrumentalities" or in repurchase agreements secured by those instruments. PCM highlighted the Fund's AAAf rating by Standard & Poor's Mutual Funds Rating Group. 18 PCM represented that the Fund would invest "only in U.S. Government securities." PCM also asserted that the Fund would "not commit funds to options, futures or so called 'derivative instruments.'" It recommended the Fund as an alternative to money market securities.
Initially, the Fund's assets were invested almost exclusively in Treasury securities and pass-through MBS issued by government-chartered corporations, such as the Federal National Mortgage Association. In 1991, without the consent of shareholders, the Fund began to shift its investments into CMOs and other complex mortgage securities, including inverse floaters. These instruments were more sensitive to changes in interest rates.
By March 1993, the overwhelming proportion of the Fund's net assets (more than ninety percent) was invested in CMOs. Although CMOs became an increasingly large portion of its portfolio composition, the Fund did not revise its disclosures in any material respect. Rather, between 1991 and 1994, Fund disclosure documents and marketing materials emphasized the relatively conservative composition of the Fund's portfolio, and its investment objective, policy, and technique of seeking high current income while preserving principal investment by maintaining a "weighted average life" of its portfolio securities of three to five years. Although by this time nearly half of the Fund's portfolio was invested in inverse floaters, PCM excluded the inverse floaters from its calculation of the portfolio's "weighted average life." PCM compared the Fund's performance to that of the Merrill Lynch three- to five-year Treasury Bond Index as a benchmark, even though the securities in the Fund'sportfolio were much more interest rate sensitive than the Merrill Lynch index.
The Fund used implied duration in its disclosure documents. From at least January 1991 through March 1994, PCM reported that the Fund had an implied duration of 3.0 to 4.3 years. 19 However, as early as September 1992, Bruntjen, in a speech to a group of state treasurers, stated that effective duration produced "a more useful analysis." 20 Goldstein testified that between 1991 and 1994 portfolio managers used implied, modified, and effective duration to measure a portfolio's sensitivity to changes in interest rates. Goldstein confirmed that she believed prior to May 1994 that effective duration "conveyed more information" regarding interest rate sensitivity.
The Fund also engaged in an on-going series of transactions sometimes referred to as the "Sale/When-issued Program." Under the Sale/When-issued Program, the Fund made a "forward commit-ment" to purchase a security at a designated price on a designated future date. In the intervening period (usually within two months) between commitment and settlement, the Fund rolled its position over, reselling its purchase commitment to the seller and entering into another commitment to purchase such securities at a later date (the "dollar roll"). The Fund received the difference between the price at which the Fund sold its security position to a dealer and the lower price at which it agreed to purchase a similar position back (the "drop"). 21 The Fund assumed any potential unrealized gain orloss arising out of the position's price on the date of the repurchase obligation in return for the drop. In its disclosure documents and marketing materials, the Fund described the drop as its "negotiated fee" or "fee income."
Because the Fund bore the full risk of the rollover security's change in value, the Sale/When-issued Program added leverage to the portfolio and increased the Fund's sensitivity to interest rate changes. 22 If the bond market rallied during the term of the dollar roll, the gains from the settlement or rolling forward of the commitment provided a direct gain to Fund. Conversely, if the bond market declined during the term of the dollar roll, any loss was borne by the Fund's shareholders. By March 1993, PCM had leveragedthe Fund's total CMO investments to as much as 149% of net assets through its Sale/When-issued Program.
Goldstein and Bruntjen knew that these activities increased the Fund's risk. 23 Nonetheless, each of the Fund's prospectuses from 1988 through February 1994 represented that Sale/When-issued Program transactions constituted a "hedge against anticipated changes in interest rates and prices" without disclosing the impact that this program had in leveraging the Fund.
Following the Fund's increased investment in CMOs, its returns significantly increased and it received increased publicity. This in turn attracted a large influx of new investor money. Between January 1992 and September 1993, the Fund's net assets increased by more than $500 million and the Fund broke multiple sales records.
However, as described in Section IV.B. below, in 1994, the CMO market collapsed, and the Fund suffered significant losses. In its 1994 Semi-annual Report, the Fund disclosed that "mortgage-backed derivative securities" had been "pivotal" to the Fund's superior performance over the previous five-year period. 24 Until the 1994 Semi-annual Report, the Fund did not disclose the material changes to the Fund's investment objective, policy, techniques, strategy, or composition.
PCM and Goldstein are charged with violations relating to material misstatements and omissions in the Fund's disclosure documents. Securities Act Section 17(a) prohibits using the mails or the instruments of interstate commerce to engage in antifraud violations in the offer or sale of securities. 25 Exchange Act Section 10(b) and Exchange Act Rule 10b-5 provide that it is unlawful for any person, directly or indirectly, in connection with the purchase or sale of a security, to make an untrue statement of material fact, omit to state a material fact, use any device, scheme or artifice to defraud, or engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person. 26 IC Act Section 34(b) prohibits any person from making false statements in registration statements, applications, and other records required under the IC Act. In addition, PCM is charged with adding and abetting the Fund's violation of IC Act Section 13(a)(3), which prohibits a registered investment company from deviating from its concentration of investments and its investment policy absent shareholder approval.
A. PCM. PCM does not challenge the law judge's finding that "PCM's risk disclosures for PJIGX contained misrepresenta-tions or omissions of material fact." The PJIGX prospectuses, annual and semi-annual reports, and marketing materials emphasized the relatively conservative composition of the Fund portfolio. These documents did not disclose the effect of the Fund's being predominantly invested in CMOs, or that the percentage of CMOs contained in the portfolio significantly increased its sensitivity tochanges in interest rates until the Fund's collapse in value in April 1994.
PCM materially deviated from the Fund's stated investment objective without shareholder consent. From the Fund's inception, PCM represented the Fund to be a conservative portfolio, investing only in short or intermediate term fixed income securities. However, the Fund's portfolio composition, duration, convexity, and leverage changed dramatically between late 1991 and early 1994, increasing Fund risk and volatility. Nonetheless, PCM failed to make meaningful disclosures concerning the increased risk that the Fund had assumed or the impact of that risk on its conservative investment objective.
PCM further misled investors by comparing the Fund's performance to the Merrill Lynch three- to five-year Treasury Bond Index. The Merrill Lynch three- to five-year Treasury Bond Index, unlike the Fund, did not include CMOs. Thus, the Fund's increasing proportion of CMOs exposed it to interest-rate sensitivity not exhibited by the Merrill Lynch three- to five-year Treasury Bond Index.
PCM also emphasized weighted average portfolio life as an appropriate risk indicator. This was a misrepresentation because weighted average life is not an appropriate measure of interest rate risk for a portfolio holding inverse floaters. A small change in the interest rate or a small change in the assumptions about future prepayment rates can dramatically affect the weighted average life calculation. Inverse floaters ranged between 30.9% and 47.4% of the Fund's CMO holdings from March 31, 1993 to March 31, 1994, yet the Fund excluded these securities from its calculation of weighted average portfolio life. As a result, the Fund's reported weighted average life did not accurately reflect its true sensitivity to interest rates.
PCM also misrepresented the Fund's risks associated with the Sale/When-issued Program. Contrary to Fund disclosures, the Sale/When-issued Program did not "hedge" risk/volatility. Rather, its leverage increased that risk. Additionally, the "fee income" terminology used in the Fund's disclosure documents ignored the risks borne by the Fund in the event the leveraged securities declined in value.
The Fund reported implied duration, an inappropriate measure of the underlying portfolio's duration, in its disclosure documents. The implied duration calculations suggested a low to moderate portfolio volatility typically associated with risk-averse investment strategies. PJIGX's CMO-driven volatility was appreciably greater than the low to moderate range which the Fund's implied duration disclosures suggested. The Fund's prospectuses, statements ofadditional information, annual and semi-annual reports dating at least through the end of 1993 did not disclose that the Fund's implied duration figures might understate the portfolio volatility.
The record contains substantial unrebutted evidence that CMO managers of ordinary competence were aware that CMO securities' uncertain cash flow characteristics could render implied duration inadequate even misleading as a measure of price sensitivity/volatility, and that Bruntjen and Goldstein were aware of the inadequacy of implied duration as a measure of CMO price sensitivity long before March 1994.
Conceding its misstatements and omissions, PCM contends that it did not act with scienter because the law judge found, based upon PCM's expert witness testimony, that PCM's prospectuses and statements of additional information complied with industry standards. 27 While compliance with industry standards is a consideration, it is only one factor to be weighed. 28 The United States Court of Appeals for the Ninth Circuit has held that the standard of care by which to measure conduct "is not defined solely by industry practice, but must be judged by a more expansive standard of reasonable prudence, for which the industry standard is but one factor." 29
PCM, through Brunjten, acted with scienter. 30 We conclude that PCM willfully violated Securities Act Section 17(a), Exchange Act Section 10(b), Exchange Act Rule 10b-5, and IC Act Section 34(b). Because the overall increase in the Fund's risk/volatility profile constituted a material deviation from the Fund's stated investment objective of high income with preservation of capital that did not receive shareholder approval, we also conclude that PCM willfully aided and abetted and was a cause of the Fund's violation of IC Act Section 13(a)(3). 31
B. Goldstein. The law judge found that Goldstein willfully violated Securities Act Sections 17(a)(2) and (a)(3) and IC Act Section 34(b). 32 Goldstein, like PCM, "is not challenging" the law judge's finding that "PCM's risk disclosures for PJIGX contained misrepresentations or omissions of material fact." Rather, Goldstein challenges the law judge's finding that Goldstein's actual Fund management authority, responsibilities, and expertise, as well as her status as a "co-manager" of the Fund, made her liable for the Fund's fraudulent disclosures. 33
Goldstein participated in the review and issuance of the Fund's disclosure documents. In particular, Goldstein admitted that she reviewed the accuracy of disclosures relating to the Fund's duration in at least some of the Fund's disclosure documents. Goldstein, a trained professional with significant fixed income analytical experience, had the knowledge and experience to assess the accuracy of those documents. Moreover, as a co-manager of the Fund, Goldstein personally computed the average life of the Fund and reviewed average life computations of the Fund prepared by others, including employees that she had trained.
Goldstein suggests that she was a peripheral participant in the Fund and its disclosures. Although Goldstein attempts to minimize her involvement and casts Bruntjen as the primary (if not sole) manager of the Fund, her own admissions and the testimony of numerous witnesses all substantiate Goldstein's responsibility for the Fund. Goldstein's duties as a Fund co-manager included participating in client presentations and executing transactions. Goldstein also admitted that typically she or Bruntjen would make the "final decision on what gets purchased or sold" in the Fund. 34 Testimony from a PCM senior vice president, a communications department employee, and a CMO trader confirms that Goldstein was recognized,with Bruntjen, as the manager of the Fund. 35 Moreover, PCM held Goldstein out to the public in the pivotal role of Fund co-manager. 36
Measuring Goldstein's accountability by a standard of reasonable prudence, 37 the record establishes that Goldstein was, at a minimum, negligent. 38 As the Fund's co-manager, and an experienced fixed income analyst who had evaluated security duration, Goldstein either knew or should have known that it was materially misleading to use an implied duration method to calculate the Fund's duration without disclosing its limitations when applied to the securities in the Fund's portfolio. 39 Goldstein's participation in this materially misleading disclosure constitutes a willful violation of Securities Act Sections 17(a)(2) and (a)(3) and IC Act Section 34(b). 40
A. The Fund's Valuation Process. Under the IC Act, PCM was required to price all of the Fund's securities on a daily basis in order to determine an accurate net asset value ("NAV"). The Fund's prospectus described the valuation process as follows:
The value of certain fixed-income securities will be provided by an independent pricing service which determines these valuations at a time earlier than the close of the [New York Stock] Exchange. Pricing services consider such factors as security prices, yields, maturities, call features, ratings and developments relating to specific securities in arriving at securities valuations. Occasionally events affecting the value of such securities may occur between the time valuations are determined and the close of the Exchange. If events materially affecting the value of such securities occur over such period, or if the Portfolio's management determines for any other reason that the valuations provided by the pricing service are inaccurate, such securities will be valued at their fair value according to procedures decided upon in good faith by the Investment Trust's Board of Directors. In addition, any securities or other assets of the Portfolio for which market prices are not readily available will be valued at their fair value. 41
In February 1993, the Fund's outside auditor expressed concern that the Fund's valuation of "derivative mortgage-backed securities, such as inverse floaters, interest and principal only strips, Z-tranche bonds and other complex products...[was] not being performed according to any prescribed procedures...." As a result, the Fund's board of directors approved a valuation methodology for determiningthe Fund's NAV. Under the methodology, PCM generally would utilize an outside pricing service to value Fund portfolio securities and would rely on the pricing service valuations to determine the Fund's NAV. In the limited circumstance that market prices were "not readily available," PCM was:
[To] value the security at the average of the highest current independent bid price and the lowest current independent asked price determined on the basis of reasonable inquiry. Such reasonable inquiry may include obtaining bid and asked prices from a recognized, reputable broker-dealer making a market in such security or asset, or obtaining such prices from a widely used quotation system such as Bloomberg or, with respect to foreign securities, Reuters.
In the event such bid and asked price quotations are not available, a security will be valued at fair value, taking into consideration yields or prices of securities of comparable quality, type of issue, coupon and maturity.
Although PCM's valuation policy contemplated using Bloomberg's quotation system to obtain bid and ask prices, Goldstein testified that, on rare occasions, she used Bloomberg to compute a bond's "fair value" and assign it a price when the Fund had not received a dealer mark 42 or PCM believed that the mark it had received was unreasonable. 43
Around March 1994, Goldstein and Nelson discussed the process PCM would follow to "override," or fair value, the price of a bond in the Fund's portfolio, but they did not inform the Fund's board of directors that PCM might use Bloomberg analytics to fair value bond prices. Nelson confirmed that the Fund's board did not approve of PCM's use of internally-generated Bloomberg analytics to obtain a fair value for a security and that there were no written procedures which specifically permitted this valuation procedure. Indeed, it was not until May 1994, after the events at issue, that Nelsondrafted a document that, for the first time, proposed the use of Bloomberg analytics to override other sources for security prices. The board did not approve this proposed valuation procedure.
PCM employed Investors Fiduciary Trust Company ("IFTC") as its accounting services provider to calculate the Fund's daily NAV. IFTC was responsible for sending the daily NAV calculation to the Fund's transfer agent (by 7:00 p.m.) and reporting it to Nasdaq (by 4:30 p.m.) for publication in the financial media. By agreement dated September 30, 1993, PCM employed Kenny S&P Evaluation Service (and its affiliate, EJV Partners) (collectively "Kenny") to provide independent evaluations on a daily basis of securities in the Fund. Kenny used its internal valuation system to provide valuations for the simple MBS. Kenny engaged in so-called "direct pricing" for the Fund's CMOs. For direct pricing, PCM gave Kenny a list of dealers from whom Kenny would obtain valuations, or "marks." Usually, the dealers that originally had sold the securities to PCM were asked to provide current marks for the securities. 44
Once Kenny received marks from dealers and completed its internal MBS valuations, it would electronically transmit those prices at approximately 3:00 p.m. for entry into the Portfolio Accounting System ("PAS"), an IFTC system on which IFTC relied. 45 The Fund's NAV report was transmitted to PCM around 4:00 p.m. The NAV report consisted of three separate documents: 1) a one-page snapshot valuation of the Fund at a given time; 2) an initial price stratification report listing all securities where the variance in price from the previous report exceeded a predetermined tolerance level; and 3) a "daily price make-up report" showing the Fund's real-time current holdings.
Promptly upon receipt of the Fund's daily initial pricing/stratification reports, PCM operations department personnel checked for missing prices and other obvious errors, and worked directly with Kenny and securities traders to correct the reports prior to portfolio manager review. 46 The portfolio manager generallyfocused on the stratification report. After correcting obvious errors such as misplaced decimal points, the manager looked for any unusual or unexpected price changes. Goldstein, as the Fund's co-manager, unilaterally could challenge prices that she deemed unreasonable.
Actual price overrides customarily resulted from direct discussions between the portfolio manager and the pricing source, whether Kenny or the broker-dealer(s) who had provided the disputed mark. If the pricing source agreed to revise the challenged mark to an amount that the portfolio manager considered reasonable, the revised price was used to calculate the Fund's NAV. If the pricing source did not revise the challenged mark, the portfolio manager generally either accepted the source's original mark or sought marks from different traders. A portfolio manager like Goldstein was required to explain to the operations department the basis for any security price override before the operations department conveyed the override to IFTC. 47 When she was satisfied with the Fund's NAV, Goldstein would sign off on the final NAV for the day, which would be relayed to IFTC for dissemination to Nasdaq and the transfer agent. Operations personnel maintained a daily pricing file for the Fund and were responsible for collecting the documentation, including Bloomberg analytics, 48 that were used to support any price override.
1. Background. By March 31, 1994 the CMO market was in turmoil. Earlier in the year, the Federal Reserve Board had initiated a series of interest rate increases. These increases negatively affected the values of most CMO securities, and funds holding these securities suffered significant losses. These losses in turn caused funds to sell off CMOs, further depressing CMO values as these securities flooded the market. From October 1993 throughMarch 30, 1994, the Fund's NAV declined almost fourteen percent, from $12.23 to $10.55 per share.
The general decline in the CMO market accelerated on March 30, 1994, as a result of a default by Askin Capital Management, Inc. ("Askin"), a large hedge fund manager, on broker-dealer margin calls. In response, traders immediately liquidated several hundred million dollars in CMOs from Askin's portfolios. The following day, March 31, 1994, was the Thursday before an extended holiday weekend (since the markets were closed the following day in observance of Good Friday) and the last day for transactions to be included in the Fund's semi-annual report. 49
On the morning of March 31, Winson and Destro discovered that Kenny's prices for a number of Fund securities were stale (and therefore unreliable) because Kenny for some period of time had not included in its valuation system all of the marks it had received. Destro informed Nelson, Johnson, and later Goldstein about the discovery of stale securities prices. 50 Winson, Destro, and Johnson tried for several hours to determine the extent of the pricing problems and to correct them. Johnson testified that discussions with Kenny disclosed that "something had broken down between the way Kenny was going out and requesting prices and getting those prices" to the Fund. These inquiries revealed that "there were securities for which [the Fund wasn't] getting current prices for some significant period of time." Ultimately they determined that "several dozen" securities, all sold to the Fund by Kidder Peabody & Co. ("Kidder"), probably had stale prices.
Destro, Goldstein, and Nelson all left PCM's offices by 5:00 p.m., but Winson and Johnson continued their attempts to determine the suspect securities' current prices by various means. They missed both the 4:30 p.m. Nasdaq publication deadline and the 7:00 p.m. transfer agent deadline. 51
PCM's efforts to secure accurate marks through Kenny and individual traders for the securities in the Fund's portfolio were also hampered because the markets would be closed the next day and traders were unavailable to provide marks. The Kidder trader from whom Winson secured some marks could not provide prices for all of the suspect securities, and Winson deemed the marks that she did receive to be unreasonably low. Winson therefore valued these securities by using PCM's internal Bloomberg analytic system to derive prices. Johnson assisted Winson by recalculating the Fund's NAV each time Winson derived another security's price on the Bloomberg system. 52 Either Winson or Goldstein orally approved the resulting NAV of $10.40 per share, which Johnson relayed to IFTC. 53
2. April 4, 1994. Over the weekend, interest rates rose by 30-40 basis points. On the morning of April 4, 1994, Winson secured marks from Kidder for the Fund's stale-priced securities, solely in an attempt to validate the prices used to calculate the Fund's NAV on March 31, 1994, and not to secure new marks for April 4, 1994. 54 Winson received marks that approximated those Kidder had provided on March 31. These marks were substantially lower than the values Winson had computed on March 31 using the Bloomberg analytics. Winson and other fund managers, 55 however, were concerned that the marks did not reflect accurate values for the securities. 56
PCM staff began to consider whether PCM should gradually reduce the stale-priced security values over a few days in order to provide additional time for PCM to confirm the securities' appropriate market values. According to Winson, PCM's staff reached a general consensus to incorporate gradually or "ratchet" the lower security prices into the Fund and the Manager's Fund, another closed-end fund managed by PCM, 57 over the intervening days before the next comprehensive fund pricing on Thursday, April 7, 1994. Winson asserts that she was to implement the gradual incorporation of losses for the Manager's Fund, while Goldstein was to implement it for the Fund. Winson testified that there was a "group" discussion and that she was uncomfortable with it. The Respondents assert that Winson initiated the proposal to reduce gradually security values in the Fund.
Winson created a pricing sheet to obtain the stale-priced securities' current marks for April 4, 1994 (the "Pricing Sheet"). This document incorporated three columns designated "New Price," "OldPrice," and "Change," with values typed into each column for each of the stale-priced securities. 58 This document also contains the following handwritten notations:
Managers (ratchet by ½) Marcy will take care of
|Our funds -->|| over 4 days if moved on Thurs|
over 3 days if no on Thurs
Johnson acknowledged that she wrote the notations, and testified that the delta signs represent the word "change." Johnson denies any recollection of the notations' underlying meaning, or that they reflect what actually was done with respect to the Fund's securities or NAV. 59
There are a number of recorded telephone conversations among PCM and IFTC personnel. 60 At approximately 10:30 a.m. on April 4, 1994, Johnson, referring to the Pricing Sheet, informed IFTC: "We would like to just slam all these things through today," 61 i.e., adjust the prices with the new marks. Portions of this and other recorded conversations provide a fuller context for this statement. Johnson testified that she wanted IFTC "to figure out for me the NAV impact of these." Thus, Johnson asked IFTC to compute "how much of a hit would we have to NAV if we just took everything right down to the new price?" Johnson then explained, "Cuz, these are the ones where they've been mispriced for a while and so we've been taking them down a little bit at a time."
Destro also spoke with IFTC on April 4. PCM had calculated, based on the figures in the Pricing Sheet, that the Fund's NAV would be reduced by approximately $0.15 per share. Destro told IFTC that PCM wanted to compute the NAV using all the updated marks. She stated that because the market went down again on Friday, PCM "could substantiate more price drops." However, Destro also expressed concern that, if the market rose, it would prevent PCM from continuing to reduce the NAV.
Around 2:00 p.m. on April 4, Destro informed IFTC that she had telecopied the Pricing Sheet, which contained the March 31 prices, to Kenny with urgent instructions directing Kenny to include these values in Kenny's April 4 pricing report. Destro also instructed IFTC to ensure that the telecopied prices in the Pricing Sheet were reflected in IFTC's April 4 initial pricing reports to PCM. Destro confirmed that PCM anticipated the resulting decline in the Fund's NAV would be approximately $0.15 per share.
IFTC used all but six of the 41 values reflected in the Pricing Sheet's "New Price" column to determine the NAV that the Fund reported on April 4. However, as discussed above, Winson had obtained the Pricing Sheet by 10:15 a.m. in an attempt to validate the prices used on March 31, 1994, not to obtain then-current prices for April 4, 1994. Moreover, the CMO market had continued to decline throughout the day on April 4, 1994. Kidder specifically cautioned Bruntjen and Goldstein that this decline would have a significant impact on the Fund. In fact, IFTC's initial pricing reports computed that the Fund's NAV had dropped by approximately $0.40 per share, to $10.01 per share.
Thereafter, PCM submitted a number of price changes to IFTC that raised the Fund's April 4th NAV to $10.10 per share. Some of these price changes increased the prices of securities reflected on the Pricing Sheet. All but one of the changes (apparently written by Goldstein) to IFTC's initial pricing report are in Nelson's handwriting. PCM's daily pricing file maintained by its operations department to substantiate price changes, however, does not evidence the basis for these changes.
In calculating the Fund's NAV, several securities were priced with stale "Old Prices" instead of "New Prices." For example, a CMO derivative designated as CUSIP 31358UA63 62 was one of the stale-priced securities. The Pricing Sheet listed its "New Price" as 55. Although this security was included in IFTC's initial pricing report at 55, in accordance with PCM's specific instructions, IFTC used the security's "Old Price" of 88 to calculate the Fund's final NAV for April 4, 1994. That security's price was reduced to 75 on April 5th, even though the market rallied somewhat on that day and Kidder's mark for it actually increased.
3. April 5, 1994. The CMO securities market rebounded somewhat on April 5, 1994. In Johnson's absence, 63 Destro managed the accounting operations for the Fund's daily valuation. IFTC's April 5 initial pricing reports to PCM reflected an NAV of $10.04 per share. After incorporating various securities price changes, IFTC informed Destro at approximately 4:17 p.m. that the indicated NAV had increased to $10.05 per share. Destro called IFTC with a price change, observing:
Destro: I'm going to jail Kelly. I'm sorry.
IFTC: I know. The people at Nasdaq are like, what? And I'm like, just put it in.
Destro then told IFTC to "put back" the price of CUSIP 3133T4SJ6 to 10.9, saying, "That got us a penny last time.... Let's hope it gets us a penny this time." 64 The following exchange then occurred:
IFTC: See where that baby goes. The wheel is spinning. Cha, cha, cha, cha, cha, cha, cha. Come on. You're right. 10.10.
Destro: It's at 10.10 now. With that one.
Unidentified: See, I told you. (laughter) Just keep changing...
Goldstein: That's one of our favorite securities of all time. (laughter)
As a result of the price change to CUSIP 3133T4SJ6, the Fund's final NAV for April 5, 1994 was $10.10 per share. During this exchange, Winson warned the others that the price of this security would have to be reduced again in the near future, and Destro agreed.
4. April 6, 1994. On the morning of April 6, 1994, Destro informed IFTC that she was telecopying a comprehensive list of all the Fund security price changes from the previous day. Destro told IFTC that she had transmitted the same document to Kenny and emphasized that it was imperative that these prices be used on April 6, 1994 for the Fund and "[e]verything that's remotely connected to Piper...." 65 After receiving IFTC's initial pricing reports, Goldstein, Winson, Johnson, and Destro conveyed numerous security price changes to IFTC. With less than a minute remaining before the 4:30 p.m. Nasdaq publication deadline, IFTC informed Goldstein that the Fund's indicated NAV was $10.09 per share. At this point, the following exchange occurred:
Johnson: Yeah. Do you want to go with 10.10?
Goldstein: I'd like to go with 10.10.
Johnson [Instructing IFTC]: Go 10.10, we'll get it there.
In accordance with Johnson's instructions, IFTC immediately reported an April 6, 1994 Fund NAV of $10.10 per share to Nasdaq for publication. Thereafter, Goldstein, Winson, Johnson, and Destro 66called IFTC to confirm that IFTC had submitted the Fund's NAV in time for the Nasdaq publication deadline. During this conversation, Goldstein and Johnson inquired about the Fund's NAV, with Goldstein asking: "How much do we need to round up a penny?" IFTC responded that an increase of less than half a cent would be sufficient to round up the factional NAV amount by a penny. Following Goldstein'sstatement, "I don't see, like, a whole half a penny," Johnson indicated that PCM would have to call IFTC back.
Shortly after this conversation, Johnson again called IFTC. Johnson requested price increases to CUSIP 33133T2SL5, from 59½ to 62, and CUSIP 3129145D2, from 33 to 35, the very same two securities that PCM had reduced in price only shortly before the Nasdaq reporting deadline. At this point, the following exchange occurred:
Johnson: See if that gets us there.
IFTC: It does, and just barely.
Johnson: Just barely is all we wanted.
As a result of these two changes, the Fund's final NAV for April 6, 1994 increased to $10.10 after this amount had already been reported to the Nasdaq for publication, and prior to the deadline for IFTC to send the Fund's final NAV to the transfer agent. 67
A. Violations in Connection with Pricing of Fund NAV. The Fund represented that it would be priced daily by an independent pricing service. It further represented that in determining securities valuations, the pricing service would consider such factors as security prices, yields, maturities, call features, ratings and developments relating to specific securities. Moreover, the Fund stated that it would use these valuations unless "market prices are not readily available." Any "fair value" determination would be made in accordance with the valuation procedures decided upon in good faith by the board of directors.
By March 31, 1994, Respondents knew that they had stale prices for securities in the Fund's portfolio. On the morning of April 4, 1994, Respondents also knew from the Pricing Sheet that the prices that the Fund had reported and used to calculate the Fund's March 31, 1994 NAV were too high, and they anticipated that the Fund's NAV would be reduced by a further $0.15 per share if the marks from the Pricing Sheet were used to calculate the NAV. Although they contest it, the record shows that Respondents determined to smooth or rachet down gradually the Fund's NAV over a period of days. It appears that Respondents sought to prevent an abrupt drop in the Fund's NAV as a result of updating the stale prices. They also wanted to slow the reduction of the NAV in case the market rebounded.
Interest rates continued to rise between March 31, 1994 and April 4, 1994. Nonetheless, Respondents used the stale March 31, 1994, marks for several securities in the Fund in order to calculate the Fund's NAV for April 4, 1994. Although Respondents anticipated a $0.15 decrease in NAV, the further diminution in value of CMOs caused a decrease in NAV of $0.40 per share. The law judge found that dealer marks were readily available. Nonetheless, Respondents resorted to a series of prices for Fund securities that have no obvious basis in the record. Respondents assert that a number of the prices used to calculate the Fund's April 4 NAV were derived using Bloomberg analytics, but many of these analytics in the record were performed over a month after the NAV was calculated. This pattern repeated itself on April 5 and 6, 1994 where initial NAV reports from IFTC indicated a lower NAV and Respondents submitted price changes in the hope that "it gets us a penny this time."
PCM and Goldstein concede that they misstated the values of certain securities in the Fund on April 4 through 6, 1994 and thatthey purposefully attempted to manipulate the Fund's NAV. 68 Respondents nonetheless argue that the resulting NAV prices were not materially misstated. PCM and Goldstein argue that the Division had to prove: (1) what constituted reasonable values for each CMO security at issue; (2) whether PCM's valuations fell within that range; and (3) if not, what, if any, effect PCM's mispricing had on the Fund's NAV.
Relying on the testimony of their expert witness, Respondents assert that the range of reasonable marks for a CMO can vary by 20% to 30%, particularly in turbulent market conditions. However, that witness admitted that he neither traded CMOs nor studied particular ranges during the relevant period for specific CMOs at issue in this proceeding. 69 Further, because PCM and Kenny secured marks directly from traders with knowledge of contemporaneous market conditions, they generally received a single mark (not a range) for almost all of the securities at issue. 70
PCM and Goldstein then argue that most of the securities identified by the law judge fall within this hypothetical 30% range. For those that do not, they insist that the impact on the Fund's NAV was negligible.
Contrary to Respondents' assertions, "[t]he materiality concept is judgmental in nature and it is not possible to translate this into a numerical formula." 71 A reasonable investor would want to know that the prices used to value the Fund's securities were stale, that the Fund was smoothing the decline in value and manipulating its NAV, and that to achieve this result the Fund was mispricing some securities. 72 The numerous recorded conversations between PCM personnel and IFTC demonstrate that PCM was concerned about slowing the reduction in the Fund's NAV and artificially maintaining its price. For example, in an April 5 conversation in which IFTC was instructed to change certain prices, Destro stated: "That got us a penny last time....Let's hope it gets us a penny this time." Even more telling, Goldstein and Johnson, in their April 6 conversation with IFTC, with Winson and Destro physically present, instructed IFTC to report for the Nasdaq publication deadline that the Fund's NAV was $10.10, knowing that IFTC currently calculated the Fund's NAV at $10.09. It was not until after $10.10 had already been reported for publication that Respondents notified IFTC to increase security prices that they had earlier reduced in order to round up by a penny the Fund's NAV to $10.10 per share.
Respondents acted with scienter. Contrary to PCM's daily pricing file policy, changes to individual security prices used to calculate the Fund's final NAV for April 4-6, 1994 were, in some cases, implemented without written substantiation. 73 In othercases, PCM inappropriately superseded the current mark for a security with its "Old Price." These changes were deliberately inaccurate and conversations among the Respondents and documen-tary evidence confirm that Respondents all knowingly were participating in a process intended to alter the Fund's NAV. We find that Respondents' actions at best were reckless. 74
B. Respondent Specific Issues. 75
1. Goldstein. Goldstein argues that the valuation of CMOs entails some judgment, which she was exercising. Nevertheless, Goldstein does not cite to any evidence that on April 4, 5, or 6, PCM received marks for any particular security from two different traders on the same day. Thus, Goldstein's general observation that fund management can make a judgment as to which of two broker quotes is likely to be the best indicator of the market is not applicable to the facts in this case.
Goldstein also stresses that the law judge identified "only a small number of securities that were actually mispriced during this period of disastrous circumstances." However, the law judge stated that he referred to "specific securities and prices only where instructive with respect to the activity at issue."
The law judge also found that Goldstein's and the other Respondents' explanations for what happened on April 4, 1994 were "not plausible" in light of the evidence, 76 and that the Respondents' after-the-fact "justifications" for the Fund NAVs reported to Nasdaq on April 5 and 6 were "spurious." 77 In particular, Goldstein was responsible for "signing off" on the Fund's NAV. In the recorded conversation from April 5, 1994, she was present when Destro requested a sufficient increase in price for CUSIP 3133T4SJ6 to raise the Fund's NAV by a penny and applauded the success of the price increase. 78 On April 6, she ordered a final NAV of $10.10 just seconds before the newspaper publication deadline when the NAV as calculated by IFTC stood at $10.09. Goldstein then asked how much she "need[ed] to round up a penny." Within moments, Johnson instructed IFTC to change two security prices whose change "just barely" achieved a rounding up of the NAV to $10.10 on thatday. Goldstein personally approved the inflated Fund NAV figures that were published from April 4 through April 6, 1994.
2. Destro. Destro asserts that she "never had the authority to determine the propriety of any price assigned to a Fund security" or to approve the Fund's NAV, and that she lacked the expertise to value a security. However, Destro was actively involved in the pricing of the Fund's securities and calculation of its NAV. She admitted that, on April 5, 1994, she was responsible for "any accounting issues that [came] up that day or pricing that might come up that day." Destro testified that she was the one who had to "make sure that all the funds are priced, everything is to the paper, handling any price changes that might come through the portfolio managers, et cetera."
When combined with Destro's recorded conversations with IFTC, her statements support the finding that Destro actively participated in fraudulently pricing the Fund's NAV. Destro participated in a price change to CUSIP 3133T4SJ6 designed to raise the Fund's NAV to $10.10 per share a level that apparently already had been reported to Nasdaq. Destro had commented to IFTC on April 4, 1994 that the Fund's NAV could not be "knocked down" if there were a market rebound as occurred on April 5. Given the rebound, the NAV had to remain constant at the previous day's level. The exchange between Destro and Winson confirms that each of them understood that CUSIP 3133T4SJ6 was priced too high at 10.9 and that they would need to reduce it subsequently to an appropriate level. 79 Destro's comment, "I'm going to jail, Kelly," reflects that she recognized the violative nature of her conduct.
Destro notes that the law judge found that her actions were "not egregious in light of the totality of circumstances" which she confronted. However, we believe that Destro clearly realized she was engaged in a process that created an artificial NAV. Destro also fails to acknowledge that the law judge also found her conduct "inappropriate and reckless in significant degree."
3. Nelson. Nelson argues that there is no evidence linking him to any scheme to alter the Fund's NAV. Nelson argues that the evidence placed him "in exactly one conversation" on April 4, 1994, in which Johnson and Destro "ran Ms. Winson's smoothing suggestion past Mr. Nelson." Nelson emphatically denies agreeing to this proposal, asserting that he instructed them to take the "full hit" by reducing the Fund's NAV to reflect current prices for securities in the portfolio.
Destro and Johnson each testified that they spoke with Nelson about smoothing prices in the Fund. Johnson explained that "the idea that was floated was as a practical way to try to deal with the situation, should they start moving these prices down over a period of days while they spent time figuring out if these were the real prices." In discussing this issue with Nelson, Johnson stated that Nelson instructed that "you need to take the full hit." 80 She added, however, that he qualified the instruction to "take the full hit" with "unless there's a specific reason to not take one...." 81
Nelson concedes that the "Pricing Stratification" initial report that IFTC sent to PCM on April 4 at 4:04 p.m. includes his handwriting. 82 The handwritten notations reflect price overrides in several securities as to which PCM rejected the prices submitted by Kenny and, according to Nelson, substituted prices "which the portfolio managers deemed more accurate." He further concedes that these overrides were in fact incorporated into the Fund's final NAVfor April 4, thereby raising the Fund's NAV from $10.01 per share to $10.10 per share.
In spite of his handwriting on the Pricing Stratification report, Nelson denies any involvement in pricing Fund securities on April 4, 1994. Instead, Nelson claims that the record demonstrates the Destro "almost certainly" performed the Fund's pricing duties on April 4. Nelson therefore posits that he could not, on April 4, have "handled PJIGX's daily pricing," asserting instead that he must have written on the Pricing Stratification Report at some later point in time. 83
In the hearing below Nelson did not suggest that Destro made the changes on April 4 -- as he does for the first time in his initial brief to the Commission. Moreover, while Nelson cites to Destro's hearing testimony to support this suggestion, her testimony related to accounting issues in connection with the valuation of the Fund on a different date, i.e., April 5, 1994. Further, Johnson testified that Nelson would occasionally perform accounting duties related to the Fund. In her investigative testimony, Johnson stated that Nelson appeared to be the one who "did all of these changes on that day" to the Fund's April 4 Pricing Stratification report. We therefore reject Nelson's argument that he had no involvement on April 4 with the price changes made to securities in the Fund's portfolio. 84
Nelson alternatively asserts that, "assuming" that he lent "operations support to Ms. Goldstein on April 4" and "made the price changes reflected" in the Pricing Stratification report, "portfoliomanagers, not operations employees, decided how to price securities in PJIGX." In essence, Nelson argues that, to the extent he engaged in price overrides of Fund securities on April 4, his actions were ministerial in nature. Nelson contends that Goldstein decided whether to override securities prices in the Fund, and argues that he had a good faith belief that Goldstein honestly discharged her professional duties. In this regard, Nelson stresses that he was not a certified public accountant and had no ability to question Goldstein's subjective valuation decisions. Thus, Nelson argues that "even if [he] did facilitate  Goldstein's price changes on April 4, 1994, that is not evidence that he committed securities fraud."
While Nelson asserts that, if he made the changes in April 4, he did so in good faith, the record indicates that appropriate broker-dealer marks were readily available on April 4, 1994, calling into question Nelson's asserted belief that Goldstein's overriding of prices was appropriate. For example, one bond, CUSIP 3133T4SJ6, appeared in the Kenny price transmission and the preliminary NAV report for April 4 priced at 10.2. As Nelson's handwriting reflects, this price was overridden and the Fund's NAV was calculated on April 4 using the final and higher price of 10.9 for that bond. According to Johnson, the final 10.9 price was "arrived at using a Bloomberg analysis," yet the Bloomberg screen included in PCM's pricing support file to support the override was printed out more than a month later. 85 According to Nelson, PCM's pricing procedures required that Goldstein provide PCM's operations department with an explanation to support the April 4 override prior to the operations department forwarding the change to IFTC. Although Goldstein generated an after-the-fact Bloomberg screen to document this override, she testified that she did not know the source of the final 10.9 price that was used and provided to IFTC. Thus, at the time that Nelson made the price change to CUSIP 3133T4SJ6 on April 4, no documentation existed indicating the source of the new price and Nelson had no reason to believe that the price change had a legitimate basis. 86
Nelson was aware of a plan to "smooth" the Fund's NAV and admits participating in discussions with Johnson and Destro about gradually reducing prices of securities in the Fund's portfolio. While Nelson asserts that he instructed the Fund to "take the full hit," he nonetheless participated in creating an artificial NAV. Other than a belated attempt to cast Destro as the PCM accounting person responsible for the April 4 changes in Fund portfolio security values, Nelson raises the same arguments that the law judge rejected. 87
* * * *
Based upon the foregoing, we find that PCM, Goldstein, Destro, Johnson, and Nelson willfully violated Securities Act 17(a), Exchange Act 10(b), Exchange Act Rule 10b-5, and IC Act Section 34(b) with respect to the pricing of the Fund's NAV on April 4, 5, and 6, 1994. We further conclude that the Respondents willfully aided and abetted and were causes of the Fund's violations of IC Act Rule 22c-1, by causing the Fund to sell, purchase, and redeem shares at prices that were not based on the Fund's current NAV, and of IC Act Section 31(a) and IC Rule 31a-1 by failing to maintain appropriate books and records in support of the Fund's financial statements. 88
IC Act Rule 22c-1(b), with certain limited exceptions, required the Fund to calculate its NAV each business day. 89 The Fund'sprospectus stated this requirement. The Division asserts that, although PCM transmitted an NAV for the Fund on a daily basis, the majority of securities in the Fund were priced only weekly. The Division notes that Kidder employees testified that they supplied marks to Kenny, with copies to PCM, only on Thursdays. PCM and Piper Jaffray personnel stated that Bruntjen and Goldstein discussed weekly CMO pricing. The IFTC daily stratification reports reflect that the number of securities showing a change in value (up or down) beyond the set tolerance level was, on average, over four times greater on Thursdays than any other day of the week.
We are unable to conclude that PCM acted with scienter in this regard. PCM contracted and continuously paid Kenny, a reputable provider, for a daily pricing service. PCM directed Kenny to rely on a variety of bond traders for Fund security price information. Even if, as alleged, PCM had actual knowledge that Kidder was providing marks to Kenny only on Thursdays, this does not prove that no other trading firm provided marks to Kenny on other days of the week or that PCM was aware that no other firms were providing marks. 90 Other factors also could have influenced the Fund's pattern of Thursday security price changes. For example, on Thursdays weekly Consumer Price Indices were announced, 52-week Treasury bill auctions occurred, and Federal Reserve business surveys were announced. Accordingly, we find insufficient evidence to conclude that PCM violated Securities Act Section 17(a) or Exchange Act Section 10(b) for a failure to calculate the Fund's NAV on a daily basis. 91
The Division and all of the Respondents appeal the sanctions imposed by the law judge. The Division seeks an increased civil money penalty as to PCM and bars and civil penalties for the individual Respondents. Respondents assert that no sanctions are warranted. 92 We are vested with discretion to determine what sanctions are appropriate in the public interest. 93
A. PCM. The law judge assessed a $2,005,000 civil money penalty against PCM based upon the numerous violations he found that PCM had committed. 94 In considering whether a penalty is in the public interest, the Commission may consider six factors: 1) fraud; 2) harm to others; 3) unjust enrichment; 4) previous violations; 5) deterrence; and 6) such other matters as justice may require. 95
PCM contends that it made full restitution to Fund shareholders and was not "unjustly enriched." It represents that it paid to shareholders more than five times the approximately $17.3 million in gross revenues that PCM earned over the life of the Fund. 96 PCM states it entered into "prompt and generous"settlements with shareholders who filed a class action against the Fund, paying approximately $70 million. 97 PCM also notes that it settled with various state regulators 98 and the National Association of Securities Dealers, Inc. ("NASD"). As a result, it paid nearly $2 million in fines and other payments. PCM contends that during the time that it continued to operate, it also instituted a number of remedial steps to enhance Fund compliance, oversight, and pricing procedures. PCM stresses that it has shown contrition and openly acknowledged its mistakes.
While PCM claims that it made "full restitution" to share-holders through "prompt and generous" settlements, the class action settlement paid shareholders slightly less than fifty cents on the dollar, before attorneys' fees and costs. 99 Some of the procedures to enhance PCM's compliance, oversight, and pricing that PCM claims to have initiated were required under orders entered against PCM and Piper Jaffray by the State of Minnesota and the NASD. 100
We reject PCM's assertion that its conduct was not egregious because it complied with industry standards. PCM engaged in a variety of fraudulent and deceitful conduct, as well as deliberate and reckless disregard of various regulatory requirements. 101
PCM argues that, if a civil money penalty is appropriate, a $2 million penalty is excessive. PCM states that the law judge imposed sanctions based on a determination that PCM committed four violations of the securities laws. PCM posits that this amount was calculated based on "third tier" penalties which provide for a penalty of up to $500,000 for each violation. 102 The law judge did not impose sanctions based on a determination that PCM committed four violations. Rather, the law judge determined that the Respondents, including PCM, "committed a minimum of four general categories of securities law violations which would constitute 'third tier' violations." 103 The law judge also stated that there was "nodoubt whatsoever that Division's recommended monetary penalty of $25 million could be substantiated by multiplying culpable Respondents' numerous individual violations by the appropriate 'tier' penalties."
PCM argues that there is no likelihood of its committing future violations, as the law judge revoked its registration, the Fund no longer exists, and none of the Fund's former portfolio managers serves as a portfolio manager today. PCM's asserts that, because it has ceased operations and has no likelihood of committing future violations, there is no basis for imposing a monetary penalty. Although the likelihood that the respondent's occupation will present opportunities for future violations is a factor to consider when determining the public interest, it is not the exclusive factor. As the law judge properly noted, a monetary penalty serves to deter other persons and entities in the securities industry from committing in the future the violations that PCM committed in this case. 104 Accordingly, the deterrent effect that a monetary penalty against PCM will have must be weighed in determining whether the penalty (including the appropriate amount) is in the public interest.
The Division asserts that an appropriate penalty is $25 million, noting that PCM established a litigation reserve of $24 million in 1997 in contemplation of this proceeding. 105
Although the law judge concluded that a $25 million sanction against PCM could be substantiated, he deemed this amount to beexcessive. 106 While we agree with the Division that PCM engaged in wide-ranging egregious conduct, PCM has ceased operations and exists in name only. Under these circumstances, we do not believe that it is necessary to impose a $25 million sanction.
Based upon our previous finding of fraud by PCM, we censure PCM and order it to cease and desist from violating or committing future violations of the federal securities laws. We revoke PCM's registration as an investment adviser and assess civil money penalties totaling $2,005,000. 107
B. Individual Respondents. The individual Respondents argue that sanctions against them are unwarranted. They assert that the law judge found that they have been "adequately sanctioned and rehabilitated through the conduct of this proceeding." The law judge did not elaborate on what he meant by this statement. In any event, in imposing sanctions, we use the factors articulated in Steadman v. SEC 108 to assess the public interest. We assess the risk of future violations in determining the appropriateness of a cease-and-desist order. 109
The Division appeals the adequacy of the sanctions imposed against the individual Respondents, asserting that the law judge failed to "mete out meaningful sanctions." The Division argues that, by finding that the individual Respondents' actions were not egregious, the law judge contradicted his numerous other findings, including that the Respondents "all knowingly were participants in a process" fraudulently to inflate the Fund's NAV, and that none of them "demonstrated any meaningful recognition or acknowledgment of the wrongful nature of their conduct." The Division requests that these Respondents be barred from association with an investment adviser or investment company and assessed monetary penalties.
We cannot agree with the Respondents that sanctions are unwarranted in this case. The violations we have found involving the Fund's NAV were not merely errors in judgment. On the contrary, the individual Respondents, all experienced professionals, engaged in the deliberate fraudulent pricing of the Fund's NAV. The NAV is critical information that investors receive about an investment company's performance. This conduct undermined the pricing process upon which fund investors rely. 110 In addition, Goldstein committed disclosure violations. We therefore believe that the individual Respondents present a risk of future violations and that the imposition of sanctions is in the public interest. 111
Examining all of the factors, we conclude that the sanctions imposed by the law judge are sufficient. In particular, we notethat the conduct at issue in this proceeding was isolated and occurred over a short period of time. The individual Respondents otherwise have unblemished records in the securities industry and it appears that none of them personally benefitted from his or her wrongdoing.
Based upon our previous findings, we censure Goldstein, Johnson, Destro, and Nelson and order each of them to cease and desist from violating or committing future violations of Securities Act Section 17(a), Exchange Act Section 10(b), Exchange Act Rule 10b-5, IC Act Sections 31(a) and 34(b), and IC Act Rules 22c-1 and 31a-1.
An appropriate order will issue. 112
By the Commission (Chairman DONALDSON and Commissioners GLASSMAN and ATKINS); Commissioners GOLDSCHMID and CAMPOS, not participating.
Jonathan G. Katz
In the Matter of
PIPER CAPITAL MANAGEMENT, INC.,
ORDER IMPOSING REMEDIAL SANCTIONS
On the basis of the Commission's opinion issued this day, it is,
ORDERED that Piper Capital Management, Inc. (PCM) be, and it hereby is, censured; and it is further
ORDERED that PCM shall cease and desist from committing or causing any violation or future violation of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, Section 13(a)(3) of the Investment Company Act of 1940, Rule 22c-1 promulgated pursuant to Section 22(c) of the Investment Company Act of 1940, Section 31(a) of the Investment Company Act of 1940 and Rule 31a-1 thereunder, Section 34(b) of the Investment Company Act of 1940, and Section 207 of the Investment Advisers Act of 1940; and it is further
ORDERED that PCM's registration as an investment adviser be, and it hereby is, revoked; and it is further
ORDERED that PCM be, and it hereby is, assessed a civil money penalty of $2,005,000 payable, in accordance with Rule 601(a), 17 C.F.R. § 201.601(a), no later than 21 days after the service of this order; and it is further
ORDERED that Marijo A. Goldstein be, and she hereby is, censured; and it is further
ORDERED that Goldstein shall cease and desist from committing or causing any violation or future violation of Securities Act Section 17(a), Exchange Act Section 10(b) and Rule 10b-5 thereunder, IC Act Rule 22c-1, IC Act Section 31(a) and Rule 31a-1 thereunder, and IC Act Section 34(b); and it is further
ORDERED that Robert H. Nelson be, and he hereby is, censured; and it is further
ORDERED that Nelson shall cease and desist from committing or causing any violation or future violation of Securities Act Section 17(a), Exchange Act Section 10(b) and Rule 10b-5 thereunder, IC Act Rule 22c-1, IC Act Section 31(a) and Rule 31a-1 thereunder, and IC Act Section 34(b); and it is further
ORDERED that Amy K. Johnson be, and she hereby is, censured; and it is further
ORDERED that Johnson shall cease and desist from committing or causing any violation or future violation of Securities Act Section 17(a), Exchange Act Section 10(b) and Rule 10b-5 thereunder, IC Act Rule 22c-1, IC Act Section 31(a) and Rule 31a-1 thereunder, and IC Act Section 34(b); and it is further
ORDERED that Molly J. Destro be, and she hereby is, censured; and it is further
ORDERED, that Destro shall cease and desist from committing or causing any violation or future violation of Securities Act Section 17(a), Exchange Act Section 10(b) and Rule 10b-5 thereunder, IC Act Rule 22c-1, IC Act Section 31(a) and Rule 31a-1 thereunder, and IC Act Section 34(b); and it is further
ORDERED that payment of the amount ordered herein shall be made by certified check, U.S. Postal money order, bank cashier's check, or bank money order payable to the Securities and Exchange Commission. The check and a cover letter identifying the respondent and the proceeding designation, Administrative Proceeding File No. 3-9657, shall be mailed or delivered by hand to the Comptroller,Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, Virginia 22812. A copy of the cover letter shall be sent to Gregory P. Von Schaumburg, Esquire, Securities and Exchange Commission, 175 West Jackson Boulevard, Suite 900, Chicago, Illinois 60604.
By the Commission.
Jonathan G. Katz
1 Piper Capital Management, Inc., Initial Decision No. 175 (Nov. 30, 2000), 73 SEC Docket 3175. Originally, seven respondents were charged in this proceeding. Worth V. Bruntjen entered into a settlement with the Commission. See Worth V. Bruntjen, Securities Act Rel. No. 7634 (Jan. 26, 1999), 68 SEC Docket 3377. We make findings here with respect to Bruntjen solely for the purposes of this opinion.
The law judge concluded that the Division did not establish that Edward J. Kohler failed reasonably to supervise Bruntjen and Goldstein. That determination is final. Edward J. Kohler, Securities Act Rel. No. 8229 (Apr. 30, 2003).
2 15 U.S.C. § 77q(a). The law judge dismissed allegations that Goldstein violated Securities Act Section 17(a)(1).
3 15 U.S.C. § 78j(b).
4 17 C.F.R. § 240.10b-5.
5 15 U.S.C. § 80a-34(b).
6 15 U.S.C. § 80a-13(a)(3).
7 The law judge also found that PCM violated Section 207 of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-7, by making untrue statements of material fact concerning Bruntjen's educational background in registration applications and reports filed with the Commission. PCM did not contest its willful violation of IA Act Section 207 or the $5,000 civil money penalty that the law judge assessed for this violation. That determination is final.
8 17 C.F.R. § 270.22c-1.
9 15 U.S.C. § 80a-30(a).
10 17 C.F.R. § 270.31a-1.
11 See supra note 7.
12 See supra note 1.
13 For a detailed explanation of the various types of pass-through securities, see generally Frank J. Fabozzi, Bond Markets, Analysis and Strategies (1989) and The Handbook of Fixed Income Securities, 5th ed. (1997).
14 The impact of declining interest rates is referred to as "prepayment" or "contraction risk." Conversely, the impact of rising interest rates is called "extension risk."
15 The distinguishing feature of a CMO is that, unlike a pass-through MBS, the CMO allows for the distribution of prepayment risk among the various bond tranches.
16 Duration is defined as the percentage change in the value of a bond for a 1% change in the yield curve.
17 The company subsequently changed its name to Piper Funds, Inc.
18 A "AAAf" rating meant that investments in the Fund had an overall credit quality of AAA.
19 During this period, the Fund's marketing materials included a pie chart disclosing the Fund's portfolio composition. Centered below the pie chart in each instance were two columns labeled "Average life" and "Implied duration" followed by the Fund's calculations (in whole or fractional years) for these measures.
20 A copy of this speech was included in the marketing materials that Bruntjen and Goldstein presented in an August 1993 meeting with a potential Fund investor.
21 The decision to invest in a dollar roll transaction depends on the value of the coupon (interest) received from the pass-through security in the intervening period between commitment and the settlement date. Assume the MBS is currently valued at 100. The investor believes that the market will drop. The investor therefore enters into a forward contract to purchase the security at 95.
At settlement, if the MBS market price is higher than the forward price, the investor will have an unrealized gain fromthe transaction. Conversely, a lower market price results in an unrealized loss. Thus, if the market price is $96, the investor purchases the MBS at the forward price of $95, and simultaneously sells it at the market price for a $1 profit. If, however, the market price at settlement is $94, the investor must purchase the MBS at the $95 forward price and incur a $1 loss.
In a dollar roll transaction, the investor both enters into a forward contract to sell the security in the future at 100 and enters into a contract to repurchase the security at 95. This 5 point spread is the "drop," which is the inducement to the investor to take the risk of entering into the contract. Sometimes, instead of delivering the security, the investor simply "rolls" his position over into a new forward contract and repurchase contract.
If the investor has sufficient credit, the investor may engage in dollar roll transactions regardless of whether the investor owns the security. However, if the investor does not own the security, the investor is at risk for any change in market price for the security when the investor must fulfill the contract at settlement.
22 As a result of the dollar roll transactions, the Fund was at risk for any price decline. If the securities' prices dropped and the Fund did not directly own the securities, it was still obligated to fulfill the forward contract at the higher price. This feature of dollar roll transactions classifies them as "leveraged" transactions and contributes to the sensitivity of the portfolio to interest rates.
23 For example, in an interview with Goldstein and Bruntjen published by Morningstar Closed-End Funds, Inc. barely a month after issuance of the January 1993 Fund prospectus, Bruntjen stated: "The [dollar] roll program is one that transfers risk from someone who doesn't have a use for it the mortgage creator to someone who is willing to assume that market risk for a limited period of time in exchange for a fee. Our funds are able to absorb the market risk of mortgages during the 90-to-120 day creation period that others, who are leveraged and have regulators looking over their shoulders, cannot tolerate. In this process, our funds serve as warehouses for mortgage originators."
Goldstein added: "At times we will realize market losses and at times realize gains from that transaction. But the fee is always positive, and, especially in a steep yield-curve environment, those fees are very substantial."
24 The "derivatives" referred to the Fund's CMOs, including inverse floaters, which at that time constituted 93% of the portfolio.
25 Pursuant to Section 17(a)(1), it is unlawful "to employ any device, scheme, or artifice to defraud." Section 17(a)(2) proscribes obtaining money or property by means of any untrue statement or omission of material fact. Section 17(a)(3) makes it illegal "to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon" a securities purchaser.
26 Violations of Securities Act Section 17(a)(1), Exchange Act Section 17(b), and Exchange Act Rule 10b-5 require scienter. See Aaron v. SEC, 446 U.S. 680, 701-02 (1980). Scienter is satisfied by a showing of recklessness. See, e.g., Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990). Violations of Securities Act Sections 17(a)(2) and (a)(3) do not require a showing of scienter. See, Aaron, 446 U.S. at 697; SEC v. Hughes Capital Corp., 124 F.3d 449, 453-54 (3d Cir. 1997).
27 The law judge made no finding with respect to compliance with industry standards for the Fund's semi-annual and annual reports, Fund summaries, and letters to shareholders.
28 See, e.g., SEC v. Dain Rauscher, Inc., 254 F.3d 852, 857 (9th Cir. 2001) (industry standard is a relevant factor for determining the standard of care, but not the controlling standard); Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d 266, 274 (3d Cir. 1998) (even a practice that is universal within an industry may still be fraudulent) (citing Chasins v. Smith, Barney & Co., 438 F.2d 1167, 1171-72 (2d Cir. 1970)).
29 Dain Rauscher, 254 F.3d at 856. PCM cites the district court decision in Dain Rauscher, which the Ninth Circuit reversed. Of the four other cases cited by PCM, none involved the adequacy of disclosures relating to investment strategy risks, and the analyses in those cases do not support PCM's argument. See Platsis v. E.F. Hutton & Co., 946 F.2d 38, 41 (6th Cir. 1991) (broker's failure to disclose to customer the amount of the production credits and markups earned on inventory sales did not violate Rule 10b-5 as there was "no established regulatory dutyto disclose these items" and therefore neither an intent to deceive nor an extreme departure from the standards of ordinary care); Messer v. E.F. Hutton & Co., 847 F.2d 673 (11th Cir. 1988) (no violation of the Commodity Exchange Act in connection with unauthorized trading on a brokerage account and reference to "industry practice" was in regard to the brokerage's decision to straddle the plaintiff's account, not the brokerage's decision to make unauthorized trades); Shivangi v. Dean Witter Reynolds, Inc., 825 F.2d 885 (5th Cir. 1987) (broker's failure to disclose to customer account executive compensation earned on trades does not itself establish scienter where customer did not establish that such information is ordinarily disclosed in the securities industry, which fact, if established, "might" have indicated to broker the danger of nondisclosure); Broad v. Rockwell Int'l Corp., 642 F.2d 929 (5th Cir. 1981) (no violation of Rule 10b-5 where record overwhelmingly indicates that the parties thought themselves under no duty to disclose in detailed fashion in the prospectus and sales materials an indenture's provisions for remote future contingencies, and plaintiff concedes insufficient evidence of scienter to establish continuing fraud).
30 See, e.g., Rent-Way Sec. Litig., 209 F. Supp.2d 493, 522 (W.D. Pa. 2002) (fraud of officer or employee is imputable to corporation when committed within scope of employment and for corporation's benefit).
31 Aiding and abetting requires a primary violation committed by another party; general awareness or knowledge by the aider and abettor that his or her actions are part of an overall course of conduct that is improper; and substantial assistance by the aider and abettor in the conduct that constitutes the violation. See, e.g., Robert L. McCook, Securities Exchange Act Rel. No. 47572 (Mar. 26, 2003), 79 SEC Docket 3421; Sharon M. Graham, 53 S.E.C. 1072, 1085 n. 35 (1998)(respondent that willfully aidedand abetted another's security law violations necessarily is a "cause" of those violations), aff'd, 222 F.3d 994 (D.C. Cir. 2000).
32 The law judge found that Goldstein acted negligently but not recklessly with respect to the Fund's disclosures. The Division did not appeal this finding.
The law judge also found that Goldstein violated Exchange Act Section 10(b) and Rule 10b-5. We dismiss these allegations with respect to the Fund's disclosures. See Aaron v. SEC, 446 U.S. 680, 701-02 (1980) (scienter is an element of a violation of Exchange Act Section 10(b) and Rule 10b-5); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 214 (1976) (scope of Section 10(b) does not extend to negligent conduct).
The law judge found that Goldstein was not liable for aiding and abetting or being a cause of the Fund's violation of Section 13(a)(3), a finding that the Division has not appealed.
33 Goldstein also asserts that she cannot be found liable for a primary violation of Securities Act Section 17(a) and IC Act Section 34(b) for disclosure violations in Fund disclosure documents, citing Wright v. Ernst & Young LLP, 152 F.3d 169 (2d Cir. 1998); Winkler v. Wigley, 2000 WL 1786345 (2d Cir. 2002) (unpublished); In re Silicon Graphics, Inc. Sec. Lit., 970 F. Supp. 746 (N.D. Cal. 1997); and In re Gap Stores Sec. Lit., 457 F. Supp. 1135 (N.D. Cal. 1978). All of those cases involve liability of a "secondary actor" for a violation under Exchange Act Section 10(b).
Unlike the individuals in those cases, Goldstein, as a result of her management authority over the Fund, and her authority over content of the disclosure documents and marketing materials, is a "primary" actor. Moreover, Goldstein fails to acknowledgethat a secondary party can still be liable as a primary violator. Cf. In re Enron Corp. Sec. Derivative & ERISA Lit., 235 F. Supp.2d 549, 588-91 (S.D. Tex. 2002) (adopting and applying as a reasonable interpretation of Section 10(b) text the Commission's proposed test that a secondary party can be liable in a private suit as a primary violator of Section 10(b) if the person, acting with the "requisite scienter," "creates" a misrepresentation relied upon by the plaintiff). See also Silicon Graphics, 970 F. Supp. at 759 ("group pleading doctrine" recognizes a presumption that statements in "prospectuses, registration statements, annual reports, press releases, or other 'group-published information,' are the collective work of those individuals with direct involvement in the day-to-day affairs of the company") (citations omitted).
34 At the hearing, Goldstein initially identified Bruntjen as the person who "typically" would make purchase and sale decisions for the Fund. However, when shown her investigative testimony from an NASD proceeding, Goldstein conceded that she had previously acknowledged that she or Bruntjen typically made these decisions.
35 A Piper Jaffray broker also testified that he would direct substantive questions about the Fund's performance to Goldstein.
36 For example, a "Quarterly Update" from 1989 used to solicit broker interest in selling the Fund contained a "PCM Profile" that interviews Bruntjen and Goldstein and identifies them as the "co-managers" of the Fund. Goldstein answered the majority of interview questions concerning management of the Fund. In marketing materials from an August 1993 presentation to a potential investor in the Fund, Goldstein is listed as one of the presenters. See also supra note 23 (describing Goldstein's interview with Morningstar).
37 See SEC v. Dain Rauscher, Inc., 254 F.3d 852 (9th Cir. 2001).
38 See supra note 32.
39 The law judge concluded that Goldstein either knew or should have known that characterizing the Fund's Sale/When-issued Program as a risk volatility hedge was materially misleading. Goldstein observes that this disclosure appears only in the Fund's prospectus. Goldstein notes that the law judge also found "the actual degree of Goldstein's participation in the substantive input with respect to PJIGX prospectuses [to be] indeterminate." In light of our finding of Goldstein's liability for materially misleading disclosures relating to the Fund's implied duration, we do not reach her liability for Fund Sale/When-issued Program disclosures.
40 See, e.g., Dowling v. Narragansett Cap. Corp., 735 F. Supp.1105, 1119 (D. R.I. 1990) ("While the line between half truths and untruths is sometimes difficult to draw, both trigger a duty to disclose any additional or contradictory facts that may be necessary to present shareholders with a complete picture and prevent them from being misled.").
41 Although there were a number of Fund prospectuses during the 1988 through April 1994 period, with minor variation, the quoted language remained consistent.
42 A mark is a dealer's estimate of a security's market price, which ordinarily falls within the market's bid/offer spread.
43 Goldstein described the "Bloomberg system" as an electronic system that communicated market news and information. Using this system, Goldstein was able to analyze financial data to "fair value" a bond. The Respondents refer to this process as "Bloomberg analytics."
44 Kidder Peabody & Co., which had sold to the Fund the majority of CMOs it held, was the primary source for the Fund's securities marks.
45 IFTC purchased PAS to perform the accounting work of calculating the Fund's NAV.
46 Goldstein had primary responsibility for the Fund's daily portfolio manager review. If Goldstein was unavailable, Winsonperformed this review for the Fund.
47 In the event that Goldstein elected to override a mark received from IFTC, she would direct either Destro or Johnson to contact IFTC with the substitute mark. Goldstein was physically present in the PCM operations department when operations notified IFTC of the override.
48 Prior to March 1994, a portfolio manager on only rare occasions resorted to Bloomberg analytics to extrapolate a price for the security.
49 PCM was also calculating the NAV for all of its 38 funds, as the numerous closed-end funds administered by PCM were priced only on Thursdays.
50 Destro testified that she did not inform the Fund's board about the stale prices and could not recall hearing that anyone else informed the board.
51 Johnson requested and received from IFTC a one-hour extension of the 7:00 p.m. transfer agent deadline. This extension was an extraordinary accommodation because it delayed IFTC fromprocessing the day's transactions for all brokerages using IFTC as their transfer agent.
52 The law judge did not find any violations with respect to the March 31, 1994 NAV calculations. That finding has not been appealed.
53 Respondents dispute who approved the Fund's NAV for March 31. Although Goldstein was out of the office by the time that the Fund's NAV was finally calculated, the record indicates that she was in telephone contact with Johnson that evening.
Winson denies that she orally approved the final NAV. On March 31 Winson could not have provided written authoriza-tion for the final NAV because IFTC took its system off-line to process the day's transactions immediately after PCM reported the final number and PCM was unable at that time to print a final report. Therefore, a final March 31, 1994 NAV report was not generated until the next business day, April 4, 1994. Goldstein initialed the final report that morning.
54 Winson also requested March 31, 1994 prices from various non-Kidder traders for these securities in order to "after-the-fact cross-check" the fair market values that PCM had assigned to the securities on March 31, 1994. According to Winson, she purposely sent the list to non-Kidder traders because she wanted "new eyes from a different viewpoint who didn't typically lookat the bonds to try and put a valuation on the bonds." With few exceptions (and small variances in the amounts), the responses from other dealers confirmed the substantially reduced marks that PCM received for the securities on March 31.
55 Johnson, without identifying the "fund managers" by name, testified that "they really believed" that the marks they had received "were really low given where they thought the real value of these securities was, and it presented a problem for the fourth [of April]."
56 The record suggests that broker-dealers may have under-valued securities liquidated from the Askin funds in order to maximize their claims as creditors in Askin's bankruptcy proceedings. The record further suggests that broker-dealers provided one another with artificially low "accommodation bids" for Askin securities. Whether broker-dealers engaged in such activities, however, is not before us in this proceeding.
57 PCM served as a sub-adviser for the Manager's Fund, which held some of the same securities as PJIGX and for which Winson had primary portfolio manager authority.
58 The record is unclear about the source of the figures in the "New Price" and "Old Price" columns.
59 The law judge observed that Johnson "exhibited extraordinary recollection and attention to detail at the hearing, and her inability to recall the underlying meaning/purpose of such a suggestive piece of evidence as her handwritten notations" seemed "improbable."
60 The Division and PCM submitted separate written transcripts of these conversations. In some instances, the transcripts are inconsistent and the parties did not agree at the hearing to one set of written transcripts. Nonetheless, the parties submitted compact discs and the Division also submitted audio tapes containing these recorded conversations. For purposes of this opinion we have relied on the recordings rather than the parties' transcriptions.
61 The person at IFTC who is recorded on virtually all the conversations is Kelly Kovac.
62 A CUSIP or Committee on Uniform Securities Identification Procedures number is used by dealers and institutional investors to identify securities, including CMO derivatives.
63 Johnson left PCM's offices at approximately noon on April 4 to attend a professional seminar and did not return to PCM until April 6. During her absence, Johnson did not participate in the Fund valuation process.
64 The April 5 initial stratification report indicated that CUSIP 3133T4SJ6 had a reported price on April 4 of 10.9, but had dropped in value on April 5 to 10.06. Therefore, "putting back" this CMO's price to 10.9 increased its value to the prior reported level.
65 The law judge found that Kenny incorporated 43 of the 44 prices from Destro's list into the April 6 pricing transmission that Kenny forwarded to IFTC.
66 Although the transcript of this conversation does not include Destro, Kelly Kovac, the IFTC representative, testified at the hearing that she recognized Destro's voice and thought she heard it in the background of this recording.
67 The Order Instituting Proceedings alleged that manipulation of the Fund's NAV occurred during the period of March 31, 1994 through at least April 8, 1994. The law judge found that no manipulation occurred on March 31. After concluding that the Fund's NAV was fraudulently mispriced on April 4-6, 1994, the law judge "deem[ed] it unnecessary to evaluate  Respondents' actions on April 7-8, 1994." The parties have not appealed the law judge's March 31 finding or his decision not to make findings with respect to the Respondents' pricing on April 7-8, 1994.
68 Nelson, Johnson, and Destro do not expressly concede that they misstated values or attempted to manipulate the Fund's NAV. However, each of them argues in general that misstatements in the value of securities in the Fund's portfolio did not result in a materially inaccurate NAV.
69 PCM's expert also confirmed that he had "no opinion of any kind" concerning the specific prices used by the Fund for CMOs during the period of March 31, 1994 through April 8, 1994, or the methods used by PCM to determine those prices.
70 Respondents PCM, Goldstein, Johnson, and Destro all cite an allegedly mispriced security as an example (CUSIP 3133T2FA3). On April 7 (a date not at issue in this appeal), Kidder marked the bond at 80 while First Boston Corporation marked the same bond at 67, "a difference of 20%." From this they conclude "that the Commission should find that the marks for CMOs vary by at least 20% in normal market conditions."
However, this is the only example on the Division's 18-page chart where two brokers provided different marks. Moreover, although PCM used the highest price (80) as the price of the bond on April 7, even though the midpoint between the two quotes was 73.5 and Kenny supplied a price of 74, Respondents provide no explanation for this choice.
71 Basic Inc. v. Levinson, 485 U.S. 224, 236, n. 14 (1988) (citation omitted). PCM also argues that the law judge, in contravention of Basic, impermissibly applied a bright-line standard that an artificially inflated NAV, regardless of any degree, is material. However, the law judge expressly rejected "a bright-line per share deviation (e.g., one percent/one penny) benchmark" for determining materiality. As discussed above, we do not apply a bright-line test here.
72 See Basic, 485 U.S. at 231-32 (an omitted fact is material if there is a substantial likelihood that its disclosure "would have been viewed by a reasonable investor as having significantly altered the 'total mix' of information made available") (quoting, TSC Indus., Inc., v. Northway, Inc., 426 U.S. 438, 449 (1976)).
73 For example, PCM made a number of price changes to IFTC's April4 initial report, but the file that PCM maintained to substantiate price changes does not evidence the basis for these changes. The record does not indicate that broker-dealer marks were unavailable on April 4, so it is at best questionable why PCM resorted to Bloomberg analytics for many of the changes. Of the Bloomberg printouts in the file, some do not provide any analytic basis for their indicated prices and others indicate on the face of the printouts that they were generated more than a month after April 4, 1994.
74 Johnson, Destro, and Nelson argue that the law judge found that they "purposefully conspired" to misrepresent and manipulate the Fund's NAV, but that the Division charged them as primary violators, not conspirators. Although the law judge used the word "conspiracy" in the Initial Decision (primarily in his initial summary of the case), the law judge did not apply the law of conspiracy to the evidence. The Order Instituting Proceedings charged these Respondents as primary violators who "engaged in a scheme" to override dealer quotations and gradually lower or "rachet down" prices of derivatives in the Fund over the course of several days. As the United States Court of Appeals for the Second Circuit held, "[p]rimary liability may be imposed 'not only on persons who made fraudulent misrepresentations, but also on those who had knowledge of the fraud and assisted in its perpetration.'" SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1471 (2d Cir. 1996)(quoting Azrielli v. Cohen Law Offices, 21 F.3d 512, 517 (2d Cir. 1994)). A respondent may not escape primary liability by claiming that he or she was simply following another's orders. SEC v. U.S. Envtl., Inc., 155 F.3d 107 (2d Cir. 1998).
75 Johnson raises arguments virtually identical to the arguments raised by the other individual Respondents. We do not separately address her arguments and resolve them consistent with our resolution of the other Respondents' assertions.
76 For the most part, the law judge did not specifically identify which Respondent explanations he found implausible. Rather, he made this determination after weighing the various claims among the parties. Cf. supra note 59.
77 In particular, the law judge identified changes to certain securities just prior to or immediately after the reporting of the Fund's NAV to Nasdaq where "the sole identifiable purpose of each of these price changes was simply to boost the April 5th and April 6th NAVs from the indicated $10.09 per share to the preferred $10.10 per share."
78 Following IFTC's disclosure that the price increase to CUSIP 3133T4SJ6 raised the Fund's NAV, Goldstein described that security as one of "our favorite securities of all time."
79 See supra page 28.
80 Winson also testified that Nelson was aware of the smoothing procedure adopted on April 4. Winson stated that Goldstein and Nelson instructed her to smooth prices when Winson questioned them about the propriety of doing so.
Nelson's only response to Winson's direct testimony on this issue was an implicit attack on Winson's credibility. Specifically, Nelson noted in his brief that Winson identified his voice in the background on one of the recorded conversations from the afternoon April 6, 1994, at a time when Nelson was out of the office attending a meeting in New York.
81 The Division asserts in addition that Nelson's instruction related to the "New Prices" that the Fund received on the morning of April 4, 1994 to substantiate its March 31, 1994 NAV calculation not to current prices for April 4, 1994. Thus, Nelson's instruction to take the "full hit" would not have resulted in a correct NAV since the prices to which he referred were not current.
82 As for the Pricing Sheet, Nelson argues that there is no evidence in the record establishing that he knew of the existence of the Pricing Sheet on April 4, 1994 or that he ever saw the Pricing Sheet. Johnson, however, testified that Nelson specifically referred to the "new price column" during the "full hit" conversation among herself, Destro, and Nelson. Moreover, Destro, Johnson, and Winson all testified that they and Nelson discussed "smoothing" the prices reflected in the Pricing Sheet.
83 Nelson asserts that "almost certainly" his writing on the Pricing Stratification report was part of a review of the Fund's pricing procedures conducted by its auditor in May 1994. Nelson does not address why, a month after the events at issue, he would have memorialized on the initial Pricing Stratification report the April 4 price changes to securi-ties in the Fund or why such memorializations were not made to the final report on that date.
84 However, we agree with Nelson that there is insufficient evidence that he had any involvement with the Fund's pricing on April 5, 1994. Destro testified to the effect that she was "completely responsible" for the operations aspects of the Fund's pricing on that day. While Nelson was in the office on the morning of April 6, it is undisputed that he left the office at approximately noon to attend a conference out of state and did not return to PCM's offices until sometime in the afternoon of April 8.
85 Goldstein testified that Johnson requested the Bloomberg screen in order to have some documentation on file.
86 In this regard, notes maintained by a Commission staff examiner of telephonic interviews with Nelson indicate that Nelson, in November 1994, conceded to the examiner that he, Goldstein, and Winson had "tried to do their best" in March and April 1994 to obtain market maker valuations, but that a number of prices used were internal "fair values." These notes further corroborate Nelson's involvement in mispricing the Fund's securities and his knowledge that PCM was not using market prices to calculate theFund's NAV.
87 Having considered Nelson's arguments and the evidence, the law judge found that the "Respondents' [including Nelson] explanations of what took place on April 4, 1994 simply are not plausible."
88 Johnson asserts that she should not be found liable for any books and records violations based upon a failure to maintain complete pricing files because she delegated "these record-keeping functions to her staff." Here, the incomplete files at issue relate to Fund pricing operations that she personally performed. We find her delegation claim to be without merit.
89 17 C.F.R. § 270.22c-1(b) ("The current net asset value of anysuch security shall be computed no less frequently than once daily, Monday through Friday....").
90 We also note that PCM's closed-end funds were priced only on Thursdays. Thus, while Kidder personnel testified about Thursday pricings, it is understandable that Kidder would provide the bulk of its marks to Kenny and PCM on Thursdays.
91 We agree with the Division's observation that "the Commission cannot allow a mutual fund adviser to hide behind a contract with a pricing service while knowingly or recklessly calculating an NAV with securities prices that it knows to be stale," as evidenced by our holding in Section V. Here, we find only that the record does not support the allegation that PCM had scienter with respect to the statement in the prospectus that the Fund's securities were priced on a daily basis.
92 All Respondents argue that, because the evidence does not support a finding of violation, no sanctions are appropriate. For the reasons set forth above, we have found that Respondents committed securities law violations.
93 See, e.g., Butz v. Glover Livestock Comm'n Co., 411 U.S. 182, 185-86 (1973) (where Congress has entrusted an administrative agency with responsibility of selecting means of achieving statutory policy, choice of sanction is not to be overturned unless it is unwarranted in law or without justification in fact); Valicenti Advisory Servs., Inc. v. SEC, 198 F.3d 62, 66 (2d Cir. 1999) (SEC's imposition of sanctions is reviewed for an abuse of discretion).
94 See supra note 7 and accompanying text. PCM has not appealed the revocation of its registration, but rather, states that the "unchallenged administrative sanction to revoke PCM's registration ensures that PCM will not have any future conduct."
95 15 U.S.C. §§ 78u-2(c), 80a-9(d)(3), 80b-3(i)(3). See, e.g., New Allied Dev. Corp., 52 S.E.C. 1119, 1130, n.33 (1996).
96 PCM contends that of the "total losses" that investors sustained, most recovered between one-half and two-thirds of their losses through a class action settlement. PCM states,however, that it is "axiomatic that investors in the Fund were prepared to accept certain risks when they invested" and that "no investor can reasonably expect PCM to make restitution for losses that resulted from accepted risks." Thus, PCM asserts that the shareholders received "full restitution" after factoring in these "accepted risks."
97 For the 50 or so shareholders who opted out of this settlement, PCM notes that it settled with them and paid $18.1 million. Of the three shareholders who elected to arbitrate their claims, PCM asserts that only one shareholder received more through arbitration than it would have received under the class action settlement.
98 PCM settled with the States of Maryland, Minnesota, Montana, North Dakota, and South Dakota.
99 Moreover, William J. Brody, a lawyer whose firm, Frederickson & Byron, had invested in the Fund and arbitrated its claim following the Fund's losses, testified that, following an award to the law firm in excess of $2.5 million in compensatory damages, punitive damages, and fees, PCM appealed the award three times before finally reimbursing the law firm for its losses.
100 Piper Jaffray, Inc. and Piper Capital Management, Inc., ConsentOrder SE9404156/TMF (Minn. Comm'r of Commerce Mar. 3, 1996); Notice of Acceptance of Acceptance, Waiver and Consent, Comp. No. C04960008 (NASD Mar. 4, 1996).
101 PCM also asserts that its conduct was not egregious because the mispricing of the Fund occurred "on only three of the six days challenged by the Division," and that "the magni-tude of that mispricing is, at most, a few cents per share." For the reasons discussed above, we do not find this asser-tion mitigating. We agree with the law judge that PCM used prices for certain CMOs that "had no legitimate basis whatsoever."
102 See 15 U.S.C. §§ 78u(d)(3)(B)(iii), 80a-9(d)(2)(C), 80b-3(i)(2)(C). According to PCM, absent a finding of addi-tional violations, the law does not permit any increase in the monetary penalty already imposed and there is no basis for the Division's demand that the penalty be increased.
103 PCM also argues that proceedings involving "sufficiently similar facts and allegations" in which the Commission settled for lower awards should serve as a guide for the appropriate level of sanctions here. However, "it is well established that respondents who offer to settle may properly receive lesser sanctions than they otherwise might have received based on 'pragmatic considerations such as the avoidance of time-and-manpower-consuming adversary proceedings'." David A. Gingras, 50 S.E.C. 1286, 1294 (1992) (quoting Nassar & Co., 47S.E.C. 20, 26 (1978)).
PCM also cites one case, Abraham and Sons Cap., Inc., I.D. Rel. No. 135 (Jan. 28, 1999), 68 SEC Docket 3525, in which a law judge imposed a third tier sanction but at less than the maximum amount. However, as the Supreme Court has made clear, a sanction imposed in one case is not invalid because it is in excess of sanctions imposed in other cases. See Butz v. Glover Livestock Comm'n Co., 411 U.S. 182, 187 (1973).
104 See 15 U.S.C. §§ 78u-2(c)(3), 80a-9(d)(3), 80b-3(i)(3) ("In considering under this section whether a penalty is in the public interest, the Commission may consider ... the need to deter such person and other persons from committing such acts or omissions....").
105 A PCM employee testified at the hearing that the reserve was taken against various outstanding litigation matters, including this proceeding.
106 The Division believes that the law judge improperly used the state regulatory penalties paid by PCM as a ceiling or cap on the amount of penalties assessed in this proceeding, and argues that the civil money penalty fails as a deterrent and does not serve the public interest. We do not believe, as the Division suggests, that the law judge "improperly linked" PCM's penalty to the fines already assessed by state regulators. We wish to make clear that settlements with other regulators do not serve to limit the amount of civil money penalties that may be assessed in any Commission action.
107 See supra notes 7 and 94.
108 603 F.2d 1126, 1140 (5th Cir. 1979) (imposition of sanctions in the public interest determined by weighing the egregiousness of the respondent's actions, the isolated or recurrent nature of the infraction, the degree of scienter, the sincerity of the respondent's assurances against future misconduct, the respondent's recognition of the wrongful nature of the conduct, and the likelihood that the respondent's occupation will present opportunities for future violations), aff'd, 450 U.S. 91 (1981).
109 KPMG Peat Marwick LLP, Exchange Act Rel. No. 43862 (Jan. 19,2001), 74 SEC Docket 384, 429 (in assessing risk of future violations, though "some" risk is necessary, it need not be very great to warrant issuing a cease-and-desist order and, absent evidence to the contrary, a finding of violation raises a sufficient risk of future violation), petition denied, 289 F.3d 109 (D.C. Cir. 2002). See also Herbert Moskowitz, Exchange Act Rel. No. 45609 (Mar. 21, 2002), 77 SEC Docket 481, 496-97 (same).
110 While the individual Respondents place great weight on the law judge's conclusion that their conduct was not egregious in light of the totality of the circumstances, they ignore that the law judge found that PCM's conduct was egregious. The violations that were attributable to PCM were caused by, and the responsibility of, all of the individual Respondents.
111 See, e.g., KPMG, 74 SEC Docket at 429.
112 We have considered all of the parties' contentions. We have rejected or sustained these contentions to the extent that they are inconsistent or in accord with the views expressed in this opinion.
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