A mutual fund manager agreed to pay over $500,000 for over-valuing odd-lot mortgage bonds and inflating the fund’s NAV. The fund manager purchased odd-lot non-agency mortgage-backed securities, which it subsequently valued by using third party prices based on round lots. As a result, the fund often increased the value of purchased bonds soon after acquisition once the fund administrator obtained prices from the third party services. The fund manager failed to adjust the prices that did not reflect the true values for the odd lot securities. Although the board’s valuation committee included members of the fund administrator, the committee relied on the fund manager to assess third party pricing inputs. The SEC also faults the firm for misleading marketing practices including performance that exceeded the relevant benchmark by as much as 1000 basis points since inception. The SEC charges the firm with failing to implement a reasonable compliance program that would have tested and detected the faulty pricing, performance, and marketing.
When a bond fund claims to outperform its index by multiple percentage points, it’s a compliance red flag. Even routine checking of marketing materials or sampling of post-sale valuations should have uncovered the pricing issues without SEC intervention. You can pay a little for compliance today, or pay a lot for noncompliance tomorrow.