UNITED STATES OF AMERICA
|In the Matter of
ORDER MAKING FINDINGS AND
IMPOSING REMEDIAL SANCTION
On September 14, 1998, the Securities and Exchange Commission (the "Commission") deemed it appropriate and in the public interest to institute this public administrative proceeding pursuant to Section 203(f) of the Investment Advisers Act of 1940 (the "Advisers Act") against Respondent Ellen Griggs ("Griggs").
In response to the institution of this administrative proceeding, Griggs has submitted an Offer of Settlement (the "Offer"), which the Commission has determined to accept. Solely for the purpose of this proceeding, and any other proceeding brought by or on behalf of the Commission, or to which the Commission is a party, and prior to a hearing pursuant to the Commission's Rules of Practice, 17 C.F.R. 201.100, et seq., and without admitting or denying the findings set forth in this order, except as to the Commission's jurisdiction over her and the subject matter of this proceeding, which Griggs admits, Griggs consents to the entry of this Order Making Findings and Imposing Remedial Sanctions (the "Order").
On the basis of this Order and the Offer of Settlement submitted by Griggs, the Commission finds that:
ELLEN GRIGGS, 44, a resident of Milwaukee, Wisconsin, formerly served as a chief investment officer of Mitchell Hutchins Asset Management, Inc. ("Mitchell Hutchins"). She served as the co-portfolio manager of the PaineWebber Short-Term U.S. Government Income Fund from its inception in March 1993 until her resignation from Mitchell Hutchins in July 1994. In addition, during her tenure at the firm, Griggs had supervisory authority over numerous other funds managed by Mitchell Hutchins.
B. Other Relevant Entities and Persons
MITCHELL HUTCHINS ASSET MANAGEMENT, INC. is a broker-dealer registered under the Securities Exchange Act of 1934 (the "Exchange Act") and an investment adviser registered under the Advisers Act. It is wholly owned by PaineWebber, Inc., a registered broker-dealer. During all times relevant to this Order, Mitchell Hutchins served as the investment adviser and administrator of the PaineWebber Short-Term U.S. Government Income Fund.
THE PAINEWEBBER SHORT-TERM U.S. GOVERNMENT INCOME FUND (the "Fund"), a diversified series of a registered, open-end, management investment company, commenced operations on May 3, 1993.1 The Fund's assets totaled approximately $1.7 billion as of November 30, 1993, and approximately $1 billion as of May 31, 1994.
STEPHEN H. BROWN ("Brown") was employed by Mitchell Hutchins as the Fund's day-to-day co-portfolio manager from September 1993 through April 1994, during which time he was subject to Griggs' supervision.
C. Mitchell Hutchins' Disclosures and Representations
Regarding the Fund's Volatility and Securities Portfolio
The Fund was offered to the public by means of a prospectus and other materials prepared by Mitchell Hutchins. The prospectus, which was incorporated into the Fund's
registration statement, stated that "[t]he Fund's investment objective is to achieve the highest level of income consistent with the preservation of capital and low volatility of net asset value" [emphasis added]. In addition, the prospectus disclosed that the Fund would invest in U.S. Government securities, including mortgage-backed securities. The appendix to the prospectus stated that the Fund had "no present intention" of investing in certain mortgage-backed securities -- IO and PO strips of collateralized mortgage obligations that were not planned amortization class bonds ("non-PAC IOs and POs").2
D. Brown Purchased IO and PO Securities That
Were Contrary to the Fund's Public Disclosures
In September 1993, Mitchell Hutchins employed Brown as the Fund's co-portfolio manager, with day-to-day responsibility for managing the Fund's portfolio. At or about that time, Griggs and another senior co-portfolio manager told Brown that the Fund was not permitted to purchase non-PAC IOs and POs. Despite these instructions, the prospectus's "no present intention" statement, and the Fund's low-volatility investment objective, between September 30, 1993, and February 14, 1994, Brown purchased six non-PAC POs and three non-PAC IOs for an aggregate purchase price of more than $162 million. By February 1994, non-PAC IOs and POs constituted approximately 6 percent of the Fund's portfolio.
In addition, Brown purchased other securities that were more volatile than permitted by the Fund's low-volatility investment objective. Specifically, during the period from October 1993 through January 1994, Brown purchased five PAC inverse IOs for a total purchase price of more than $34 million.3
As a result of Brown's purchases of these securities, Mitchell Hutchins' public disclosures regarding the Fund's volatility and contents became materially false and misleading. The Fund ceased being a low-volatility fund when Brown purchased non-
PAC IOs and POs and inverse IOs for its portfolio. Mitchell Hutchins' statement in the Fund's prospectus that the Fund had "no present intention" of investing in non-PAC IOs
and POs also became materially false and misleading when Brown commenced his purchases of those types of securities.
As a result of the foregoing, Brown willfully violated Section 17(a) of the Securities Act of 1933, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Moreover, as a result of the foregoing, Brown willfully aided and abetted and caused violations of Sections 13(a)(3) and 34(b) of the Investment Company Act of 1940 (the "Investment Company Act").
E. Brown Frequently Mispriced Certain Portfolio Securities
The Fund's portfolio was valued as of the end of each trading day. The Fund received from its custodian bank (the "custodian") a daily report of prices for each of the portfolio securities where dealer quotations could be obtained; these prices, in turn, provided the principal basis for the daily calculation of the Fund's net asset value ("NAV"). Consistent with the valuation method disclosed in the Fund's prospectus and statement of additional information, the custodian-provided prices, in most instances, reflected quotations received from a pricing service or a dealer (usually the dealer that sold the security to Mitchell Hutchins). In certain instances, Mitchell Hutchins' procedures permitted portfolio managers to "override" custodian-provided prices.
From October 1993 through April 1994, Brown routinely overrode prices provided by the custodian, altering the prices of approximately 5 to 25 securities a day. On more than 40 occasions, Brown overrode custodian-provided prices for a particular security for more than a two-week period. Moreover, he overrode custodian-provided prices for two of the non-PAC securities for almost the entire time they were held by the Fund.4
Contrary to the Fund's disclosed valuation method, Brown overrode custodian-provided prices with prices that he derived based on his own method, which did not take into account whether the securities currently could be sold at the prices he calculated. When Brown overrode custodian-provided prices, he frequently replaced them with higher prices. Because the Fund's NAV is a function of the value of its securities
portfolio, Brown's overrides caused the NAV to be overstated. Moreover, Brown did not retain any documentation to support his override prices.
Brown's overrides had the effect of obscuring the increased volatility of the Fund's NAV caused by his purchases of non-PAC IOs and POs and inverse IOs. This, in
turn, had the effect of obscuring his purchases of those securities. Brown further obscured the volatile effects of these securities by employing a method that materially understated the Fund's aggregate duration, a statistic that generally measures how the portfolio's value will change in response to specified changes in interest rates.
As a result of the foregoing, and as a result of his purchases of volatile securities contrary to the disclosures in the Fund's prospectus and registration statement, Brown willfully aided and abetted and caused Mitchell Hutchins' violations of Sections 206(1) and 206(2) of the Advisers Act. Moreover, Brown willfully aided and abetted and caused violations of Section 31(a) of the Investment Company Act and Rule 31a-1(a) thereunder.5
F. Griggs Failed Reasonably to Supervise Brown
Griggs failed reasonably to supervise Brown, a person subject to her supervision, with a view to preventing Brown's violations of the federal securities laws. Griggs did not effectively delegate her supervision of Brown to anyone else at Mitchell Hutchins. Although Griggs did undertake efforts to ensure the low volatility of the Fund's NAV, those efforts were not sufficient to prevent or detect the violations committed by Brown. For example, near the commencement of Brown's tenure at Mitchell Hutchins, Griggs instructed him that the Fund was not permitted to purchase non-PAC IOs and POs. However, Griggs did not review Brown's purchases of portfolio securities or the contents of the Fund's portfolio to ensure his compliance with the low-volatility investment objective and "no present intention" statement set forth in the prospectus.
To monitor the Fund's volatility, on a daily basis Griggs reviewed (1) reports of the Fund's NAV calculated out to five decimal places and (2) reports of the portfolio's aggregate duration. However, the accuracy of the NAV calculation depended on the accuracy of the pricing of the portfolio securities. Griggs never reviewed Brown's methods in valuing portfolio securities or overriding custodian-provided prices. Similarly, Griggs relied on Brown's reports of aggregate duration without reviewing his method in performing the necessary calculations. By inflating the value of portfolio securities (thereby inflating NAV) and materially understating aggregate duration, Brown obscured the increased NAV volatility resulting from his purchase of inappropriate securities, thereby circumventing Griggs' limited supervision.
Griggs' supervision of Brown was inadequate in that it ceded to Brown virtually total control over the purchase and valuation of portfolio securities with little or no effective oversight. As a result of the foregoing, Griggs failed reasonably to supervise
Brown with a view to preventing, within the meaning of Section 203(e)(6) of the Advisers Act, his violations of the federal securities laws.
In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer of Settlement submitted by Griggs and to impose the sanctions agreed to in that Offer.
Accordingly, IT IS HEREBY ORDERED THAT:
A. Griggs be, and hereby is, suspended from association with any investment adviser for a period of one month, effective on the second Monday following the entry of this Order;
B. Griggs be, and hereby is, suspended from acting in any supervisory capacity with any investment adviser for a period of four months immediately following her suspension from association;
C. Griggs shall, within 30 days of the entry of this Order, pay a civil money penalty in the amount of $10,000 to the United States Treasury. Such payment shall be: (a) made by United States postal money order, certified check, bank's cashier's check or bank money order; (b) made payable to the Securities and Exchange Commission; (c) hand-delivered or mailed to the Office of the Comptroller, U.S. Securities and Exchange Commission, 6432 General Green Way, Stop 0-3, Alexandria, VA. 22312; and (d) submitted under cover of a letter that identifies Griggs as the Respondent in these proceedings, the file number of these proceedings (AP File No. 3-9703), and the Commission's case number (HO-2955). A copy of the cover letter and money order or check shall be sent to Richard Sauer, Assistant Director, Division of Enforcement, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0803; and
D. Griggs shall, within 30 days after the expiration of each of the suspensions described above in paragraphs III.A. and B., provide the Commission with an affidavit that she has complied with the terms of said suspension. Such affidavit shall be sent to Richard Sauer, Assistant Director, Division of Enforcement, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0803.By the Commission.
|1||The Fund later was renamed The Paine Webber Low Duration U.S. Government Income Fund.|
|2||IOs and POs with prepayment protection, or "PAC bonds," are designed to provide relatively predictable payments according to an established schedule, provided that repayments on the underlying mortgage assets fall within a certain range (i.e., as long as early payoffs by mortgagors fall within certain parameters). Non-PAC IOs and POs, on the other hand, are significantly more volatile because, among other things, they lack prepayment protection and absorb the effects of changes in prepayments for PAC classes. Indeed, the Fund's prospectus stated that non-PAC IOs and POs "are extremely sensitive to the rate of principal payments (including prepayments) on the underlying [m]ortgage [a]ssets."|
|3||Inverse IOs, which may be either PAC or non-PAC, vary inversely with certain stated interest rates. These securities generally are more volatile than other IO securities because of their extreme sensitivity to interest rate fluctuations.|
|4||On September 30, 1993, Brown purchased the first non-PAC PO; he subsequently overrode custodian-provided prices for that security from October 18 until January 25, 1994, when he sold it. He purchased a non-PAC IO on October 20, 1993, and overrode its custodian-provided prices every day from November 2, 1993, through February 14, 1994, when he sold it.|
|5||Without admitting or denying the Commission's findings, Mitchell Hutchins and Brown each previously settled administrative proceedings filed against them. See In the Matter of Mitchell Hutchins Asset Management, Inc., Admin. Proc. File No. 3-9383, Securities Act of 1933 Rel. No. 7444; Securities Exchange Act of 1934 Rel. No. 39001; Investment Advisers Act of 1940 Rel. No. 1654; Investment Company Act of 1940 Rel. No. 22805 (Sept. 2, 1997); and In the Matter of Stephen H. Brown, Admin. Proc. File No. 3-9704, Securities Act of 1933 Rel. No. 7579; Securities Exchange Act of 1934 Rel. No. 40435; Investment Advisers Act of 1940 Rel. No. 1751; Investment Company Act of 1940 Rel. No. 23434 (Sept. 14, 1998).|
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