UNITED STATES OF AMERICA
In the Matter of
|ORDER INSTITUTING ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS PURSUANT TO SECTION 203(e) OF THE INVESTMENT ADVISERS ACT OF 1940, AND SECTION 9(f) OF THE INVESTMENT COMPANY ACT OF 1940 AS TO DAVIS SELECTED ADVISERS- NY, INC.|
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative and cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 203(e) of the Investment Advisers Act of 1940 ("Advisers Act"), and Section 9(f) of the Investment Company Act of 1940 ("Investment Company Act") against Davis Selected Advisers-NY, Inc. ("DSA-NY" or "Respondent").
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over Respondent and the subject matter of these proceedings, which are admitted, Respondent consents to the entry of this Order Instituting Administrative and Cease-And-Desist Proceedings, Making Findings and Imposing Remedial Sanctions Pursuant to Section 203(e) of the Investment Advisers Act of 1940, and Section 9(f) of the Investment Company Act of 1940 ("Order"), as set forth below.
On the basis of this Order and Respondent's Offer, the Commission finds that:
1. DSA-NY is a registered investment adviser located in New York, New York, and is wholly owned by Davis Selected Advisers, L.P. ("DSA"). During the relevant period, pursuant to a services agreement, DSA-NY provided services for some DSA clients, including the Davis Growth Opportunity Fund (the "GO Fund"), a series of the Davis Series, Inc. investment company. Pursuant to a sub-advisory agreement, effective December 31, 1998, DSA-NY was also the sub-adviser to the GO Fund.
OTHER RELEVANT ENTITIES
2. DSA is a Colorado limited partnership that registered with the Commission as an investment adviser in January 1988. During the relevant period, DSA was the investment adviser to seven registered investment companies (the "Fund Complex"), including Davis Series, Inc., of which the GO Fund was a series. In 2000, DSA managed approximately $29 billion for the Fund Complex and approximately $8.5 billion for 97 individual accounts and 12,000 wrap fee accounts.
3. The GO Fund commenced operation on May 1, 1984. Its stated investment objective is growth of capital, with a focus on small- to mid-cap companies. From January 1, 1999 through December 31, 2000, the GO Fund grew principally through return on investments or appreciation, by approximately 44% to $167 million in total net assets.
DSA-NY'S IPO TRADING FOR THE GO FUND
4. When DSA-NY assumed management of the GO Fund in 1999, in the words of DSA-NY's head trader (the "Trader"), there was a "mania" or "hype" in the IPO market for small- to mid-cap technology stocks. DSA-NY and the Trader believed that the Trader might be able to trade profitably in these IPOs by purchasing IPO shares and selling, or "flipping," the shares on the same or next trading day.
5. DSA-NY, however, believed that such IPO investments were risky because they involved companies with no proven histories or financial track records. DSA-NY also believed that the IPO mania could end at any moment. DSA-NY, therefore, limited the Trader's discretion to trade in IPOs in at least three respects. First, the Trader was allowed to only risk a small percentage of the GO Fund's assets in the IPOs.Second, the Trader was to invest in IPOs only when he believed that there would be significant post-IPO demand for the stock and that the IPO shares could be immediately sold at a profit. Third, the Trader was to sell promptly the IPO shares and to not allow the IPO shares to become long-term investments, unless research by DSA-NY personnel supported a longer holding period.
6. Beginning in 1999, the Trader began trading IPOs pursuant to his limited discretion. Specifically, during 1999 and 2000, the Trader exercised his discretion to trade in a total of 182 IPOs - 90 IPOs in 1999 and 92 IPOs in 2000. The vast majority of these IPOs were by companies in the broad technology sector (e.g., telecommunications, e-commerce, Internet software, networking, computer software).
7. The Trader stayed within the limitations DSA-NY laid down. The Trader's average IPO investment was approximately $59,943 in 1999 (which represented approximately .047% of the GO Fund's net asset value as of December 31, 1999) and $63,571 in 2000 (which represented approximately .046% of the GO Fund's net asset value as of December 31, 2000). The Trader invested a total of $11.2 million in the IPOs - $5.4 million in 1999 and $5.8 million in 2000. In the vast majority of instances, the Trader flipped the IPO shares. Specifically, in 159 of the 182 IPOs, the Trader sold the GO Fund's IPO shares on the same or next trading day. On average, the GO Fund held the IPO shares for less than 2.3 days.
8. The Trader's IPO trading for the GO Fund was very profitable. Specifically, of the 182 IPOs in which the GO Fund traded, 178 trades generated profits totaling over $14 million, while 4 resulted in losses of only about $15,455. The GO Fund's average profit on each IPO trade was almost $77,000, an average gain of 124% per IPO. The Trader monitored the profitability of these IPO trades.
9. The Trader's IPO trading had a significant effect on the GO Fund's performance for 1999 and 2000. In 1999, the GO Fund's net profit from the IPO trading was approximately $6.7 million, which constituted 22% of the Fund's approximately $30.6 million gain for the year and accounted for approximately 25% of the GO Fund's 31.45% total return (i.e., with the IPO trading, the GO Fund produced a 31.45% return; without that trading, its return would have been approximately 23.36%). In 2000, the GO Fund's net profit from the IPO trading was approximately $7.3 million, which constituted approximately 48% of the Fund's total $15.1 million total net gain for the year and accounted for approximately 47% of the GO Fund's 11.49% total return (i.e., with the IPO trading, the GO Fund produced an 11.49% return; without the IPO trading, its return would have been 6.08%).
10. DSA-NY and the Trader knew that the short-term IPO trading had a positive effect on the GO Fund's performance. The Trader knew that the GO Fund's short-term IPO trading added about 25% to the Fund's performance in 1999 and almost 50% in 2000.
THE GO FUND DISCLOSURE
11. DSA-NY provided disclosure to shareholders and investors through the GO Fund's 1999 and 2000 prospectuses, Statements of Additional Information, and its 1999 and 2000 annual reports (collectively "disclosure documents"). These disclosure documents were filed annually with, and transmitted to, the Commission pursuant to the Investment Company Act.
12. DSA-NY, however, failed to disclose certain material information regarding its trading in IPOs for the GO Fund and the effect of the IPO trading on the GO Fund's performance.
13. The GO Fund's disclosure documents described the GO Fund's investment strategy as holding investments for the long term. In announcing the change in sub-adviser to DSA-NY, the GO Fund's 1998 annual report stated that DSA-NY would "apply [the] Davis investment discipline-buying growth at value prices and holding for the long term-to small and mid-sized companies." Similarly, the GO Fund's 1999 and 2000 prospectuses stated that DSA-NY's investment philosophy was to purchase "common stock of quality overlooked growth companies at value prices and to hold them for the long-term."
14. The GO Fund's disclosure documents, however, did not contain any specific disclosure regarding DSA-NY's short-term IPO trading for the GO Fund. Although the GO Fund's 1999 and 2000 annual reports contained a chart showing all of the Fund's securities purchases (including the IPO shares) and the date of the purchase and a separate chart showing all of the Fund's securities sales, the date of the sale and the gain or loss on the sale, the disclosure documents did not identify any of the securities as IPO securities and did not discuss specifically the GO Fund's trading in IPO securities. In addition, the GO Fund's disclosure documents did not disclose the overall effect of the GO Fund's short-term trading in IPO securities on its periodic performance.
15. The GO Fund disclosed its performance in annual reports to shareholders. For example, the 1999 annual report stated that: "The [GO Fund] delivered a total return on net asset value of 31.45% for the one-year period ended December 31, 1999, outpacing the 21.04% return of the Standard & Poor's 500 Index." Similarly, the GO Fund's 2000 annual report stated in relevant part: "The [GO Fund] delivered a total return on net asset value of 11.49% for the one-year period ended December 31, 2000, outdistancing the performance of the Standard & Poor's 500 Index and the average multi-cap core fund tracked by Lipper Analytical Services."
16. The GO Fund's 1999 annual report stated that technology companies "were the most significant contributors to the Fund's good performance in 1999." The GO Fund's 2000 annual report cited the "outstanding performance of many of the Fund's health-care holdings." The 2000 annual report also stated that "[t]he technology area...which had helped performance so much in 1999, faced tremendous headwinds in 2000...and the [Fund] was certainly not immune."
17. The GO Fund's 1999 and 2000 annual reports did not state, however, that: (i) in 1999, the GO Fund's short-term trading in IPOs of technology companies contributed substantially to the performance of the GO Fund; and (ii) in 2000, the GO Fund's short-term IPO trades both reduced the overall negative impact of the GO Fund's technology investments and contributed significantly to the periodic performance of the GO Fund as a whole.
VIOLATIONS OF SECTION 34(b) OF THE INVESTMENT COMPANY ACT
18. Section 34(b) of the Investment Company Act prohibits any person from making any untrue statement of a material fact or omitting to state any material fact in order to prevent the statements made from being materially misleading in any registration statement, application, report, account, record or other document required to be filed or transmitted pursuant to the Investment Company Act or keeping of which is required pursuant to Section 31(a) of the Investment Company Act. Section 30 of the Investment Company Act and rules thereunder require a registered investment company to file, among other documents, financial statements, prospectuses, annual reports, and semi-annual reports.
19. A fact is material if there is a "substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information available." Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988) (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)).
20. With respect to fund performance, a registered investment company (fund or mutual fund) is required to disclose those factors that materially affected the fund's performance during its last fiscal year, including the investment strategies and techniques used by the investment adviser. Item 5 of Form N-1A requires disclosure of "the factors that materially affected the [f]und's performance during the most recent completed fiscal year, including the relevant market conditions and the investment strategies and techniques used by the [f]und's investment adviser." The Commission's adopting release further explains "Item 5(a) . . . requires funds to explain what happened during the previous fiscal year and why it happened. The narrative must describe what techniques or strategies, within the fund's investment objectives and limitations, management used that, together with market conditions and events, resulted in performance of the fund." Disclosure of Mutual Fund Performance and Portfolio Managers, IC Rel. No. 19382 (Apr. 6, 1993). This disclosure may be provided in the investment company's annual report.
21. DSA-NY failed to disclose specifically in the GO Fund's prospectuses or 1999 and 2000 annual reports a factor that materially affected its performance during its previous fiscal year, including an investment strategy and technique used by DSA-NY. In particular, DSA-NY did not disclose specifically the nature or extent of the GO Fund's short-term IPO trading. In addition, DSA-NY never disclosed the material impact that the short-term IPO trading had on the Fund's performance despite the fact that the IPO flipping was not only a new technique that the GO Fund was experimenting with, but also was easily isolated and separately identifiable from other performance factors.
22. Reasonable investors would likely have considered this omitted information material, especially considering that the short-term IPO trading had a significant impact on the GO Fund's performance and that such performance would probably not continue when there was a cooling in the IPO market or if the GO Fund grew significantly.
23. As a result of the conduct described above, DSA-NY willfully violated Section 34(b) of the Investment Company Act which makes it "unlawful for any person to make any untrue statement of a material fact in any registration statement, application, report, account, record, or other document filed or transmitted pursuant to this title...or to omit to state therein any fact necessary in order to prevent the statements made therein, in light of the circumstances under which they were made, from being materially misleading." DSA-NY knew, or should have known, about the nature of the GO Fund's short-term IPO trading and the material impact of the Fund's IPO trading on the GO Fund's performance for 1999 and 2000. The GO Fund's 1999 and 2000 disclosure documents were misleading in that they omitted to disclose the Fund's IPO trading and the significant effect that the IPO trading had on the Fund's performance.
In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions specified in Respondent DSA-NY's Offer.
ACCORDINGLY, IT IS ORDERED that:
A. Pursuant to Section 9(f) of the Investment Company Act, Respondent DSA-NY shall cease and desist from committing or causing any violation and any future violation of Section 34(b) of the Investment Company Act;
B. IT IS FURTHER ORDERED that Respondent shall, within 30 days of the entry of this Order, pay a civil money penalty in the amount of $10,000.00 to the United States Treasury. Such payment shall be: (1) made by United States postal money order, certified check, bank cashier's check, or bank money order; (2) made payable to the United States Securities and Exchange Commission; (3) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, Virginia 22312; and (4) submitted under a cover letter that identifies DSA-NY as Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be simultaneously sent to Solomon R. Mangolini, Attorney, Pacific Regional Office, Securities and Exchange Commission, 5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036.
By the Commission.
Jonathan G. Katz
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