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SEC Charges Investment Managers for Misconduct in CDO Collateral Selection Process


Washington D.C., Dec. 12, 2013 —

The Securities and Exchange Commission today charged the managing partners of a Charlotte, N.C.-based investment advisory firm for compromising their independent judgment and allowing a third party with its own interests to influence the portfolio selection process of a collateralized debt obligation (CDO) being offered to investors.

The investment managers have agreed to collectively pay more than $472,000 and exit the securities industry to settle the SEC’s charges.

According to the SEC’s order instituting settled administrative proceedings, disclosures to investors indicated that NIR Capital Management LLC was solely selecting the assets for Norma CDO I Ltd. as the designated collateral manager.  However, NIR’s Scott H. Shannon accepted assets chosen by hedge fund firm Magnetar Capital LLC for the Norma CDO’s portfolio, and Joseph G. Parish III allowed Magnetar to influence the selection of some other assets.  Shannon himself called at least one of the residential mortgage-backed securities (RMBS) ultimately included in the portfolio a “real stinker.”  Magnetar bought the equity in the CDO but also placed short bets on collateral in the CDO and therefore had an interest not necessarily aligned with potential long-term debt investors that relied on the CDO and its collateral to perform well. 

The SEC also today announced charges against Merrill Lynch, which structured and marketed the Norma CDO. 

“Shannon and Parish could not serve two masters,” said George S. Canellos, co-director of the SEC’s Division of Enforcement.  “They allowed Magnetar to influence asset selection and abdicated their duty to pick only the assets they believed were best for their client.” 

According to the SEC’s order, NIR initially was unaware when Magnatar purchased $472.5 million in long exposure to RMBS for the Norma CDO in August and September 2006 based on information that NIR provided to Magnetar that was preliminary and not intended as a basis for actual collateral selection.  By the time it learned about the purchases in November 2006, NIR already had purchased a substantial portion of the RMBS collateral.  Nevertheless, NIR used its own internal credit metrics to analyze the collateral that Magnetar purchased, and Shannon then sought to exclude some of the RMBS collateral that Magnetar had acquired and selected.  NIR, however, ultimately incorporated the collateral that Magnetar purchased in the closing portfolio.  Shannon explained to an NIR credit analyst that the final portfolio included a number of trades that NIR did not execute, and “this leaves us with several names we probably would not want...” 

According to the SEC’s order, Parish allowed Magnetar to exercise so-called approval rights by permitting the firm to be involved in the process of selecting CDO assets acquired for the portfolio.  As a result, Parish knew that Magnetar was the short counterparty for much of the Norma CDO’s synthetic exposure to CDO securities.  NIR attested in the collateral management agreement with the Norma CDO that it would act in good faith and exercise reasonable care in selecting the portfolio.  However, the CDO and its debt investors knew nothing about NIR’s compromised decision-making with Magnetar involved in the collateral selection process.

Shannon and Parish consented to the SEC’s order finding that Shannon violated Sections 206(1) and (2) of the Investment Advisers Act of 1940 and Parish violated Section 206(2).  Shannon agreed to be barred from the securities industry for at least two years and must pay disgorgement and prejudgment interest of $140,662 and a penalty of $116,553.  Parish agreed to be suspended from the securities industry for at least 12 months and must pay disgorgement and prejudgment interest of $140,662 and a penalty of $75,000.  Without admitting or denying the SEC’s findings, Shannon and Parish consented to cease and desist from violating respective Sections of 206 of the Advisers Act.  They have agreed to dissolve the NIR business.

The SEC’s investigation was conducted by Steven Rawlings, Tony Frouge, Sharon Bryant, Kapil Agrawal, Douglas Smith, Howard Fischer, and Daniel Walfish with assistance from Gerald Gross and Joshua Pater of the New York Regional Office.  They were assisted by examiners Edward Moy, Luis Casais, and Thomas Shupe in the New York office.


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