Closed-end Fund Manager to Reimburse $45 Million for Derivatives Losses
A fund manager agreed to reimburse investors over $45 Million, and its sub-adviser agreed to pay over $2 Million in disgorgement, penalties, and interest, in connection with misleading investors about the use of derivatives. The SEC charges that the fund manager marketed a closed-end fund as a risk-managed fund using covered calls to ensure current income and protect against downside risk. However, the sub-adviser utilized out-of-the-money put options and short variance swaps to significantly enhance returns, and, according to the SEC, increase the fund’s risk profile. When the credit markets collapsed in 2008, the fund experienced a 72% two-month NAV decline. The SEC says that the fund failed to specifically disclose the derivatives strategy, its impact on the NAV, and its risks either in the registration statement or its shareholder reports. The SEC charges the adviser with failing to supervise the sub-adviser and charges the sub-adviser with making misleading statements in the annual and semi-annual reports. The SEC has also brought charges against two portfolio managers.
OUR TAKE: Firms must review disclosure on an ongoing basis to make sure that it reflects current portfolio practices and not those that existed at the time of fund launch. This is especially true with closed-end funds that are not required to file an amended registration statement every year, but, instead, rely on the annual reports for updates to shareholders. The same principle applies to private funds, which are subject to the anti-fraud rules.