SEC Charges Firm Mispriced Two Junk Bond Funds

December 11, 2003 ( - The US Securities and Exchange Commission has slapped civil fraud charges on fund manager Heartland Advisors, Inc., and 13 others in connection with the running of two junk bond funds.

According to an SEC announcement, charges were also levied against Heartland’s CEO, two portfolio managers, four officers, five directors, a pricing service and one individual. The commission alleged violations in three primary areas – fund pricing, insider trading, and disclosures that relate to two high-yield municipal bond funds managed by Heartland. The value of the funds, and a smaller related fund, dropped by approximately $93 million between September 28 and October 13, 2000, when Heartland sought to correct months of deliberate mispricing, the SEC said.

Named in the suit were:

  • Heartland Advisors, Inc.
  • William Nasgovitz, president and CEO
  • Paul Beste, COO
  • Jilaine Bauer, general counsel
  • Kevin Clark, senior vice president of trading
  • Kenneth Della, treasurer
  • Thomas Conlin and Greg Winston, former portfolio managers
  • Hugh Denison, associated director
  • Independent Directors John Hammes, Gary Shilling, Allen Stefl, and Linda Stephenson
  • FT Interactive Data Corp., an independent pricing service
  • Raymond Krueger, a friend and client of Nasgovitz.

The defendants were accused of misrepresentations, mispricing and insider trading in the two high yield bond funds. Heartland Advisors, a Milwaukee investment adviser, manages the Heartland Group complex of mutual funds.

Failure to Follow Up

In its complaint, the commission charged Heartland, Nasgovitz, Beste, Bauer, Clark, Conlin, and Della with fraudulently pricing bonds in the funds. The commission alleged that the funds’ directors caused some of Heartlands’ pricing violations when they failed to adequately follow up and resolve concerns about pricing issues that came to their attention. The commission charged FT Interactive with aiding and abetting and causing certain Heartland pricing violations.

The commission also charged that Nasgovitz, Bauer, Winston, Della and Krueger engaged in insider trading in the shares of the funds when they sold their shares, and/or tipped others to do so, while aware that the funds had liquidity and pricing problems.

According to the civil suit, Heartland, through Nasgovitz, Beste, Bauer, Clark, Conlin and Winston, misrepresented and left out material facts in the offer and sale of shares in the funds. The misrepresentations and omissions related to the risks of investing in the funds, the credit research on the bonds purchased and held by the funds, the credit quality of the bonds held in the funds and the liquidity of the funds.

“The fraud in this case touched all levels of the operations of these mutual funds and two areas critical to investor confidence, disclosure and pricing,” said Mary Keefe, Regional Director of the SEC’s Midwest Regional Office in Chicago, said in a statement. “It illustrates that mutual fund directors must do more than inquire about issues that come to their attention. They have a duty to take affirmative action to follow up and resolve those issues in order to fulfill their obligations to investors under the Investment Company Act.”


The SEC’s complaint, alleges that Heartland, through Nasgovitz, Beste, Bauer, Clark, Conlin and Winston misrepresented the funds’ NAVs and, in commission filings and promotional materials, their efforts to manage certain risks associated with investing in the funds. For example, Heartland represented that it was actively managing the funds to minimize share price fluctuation when it was not doing so.

Heartland also represented that it performed intensive credit research and limited the percentage of unrated high yield bonds held by funds. Actually, Heartland conducted inadequate research and the vast majority of bonds held by the funds were unrated and relatively illiquid, the SEC said. Finally, Heartland misrepresented that it and the funds’ Board of Directors would monitor and maintain sufficient liquidity in the funds’ portfolio holdings to make sure that the funds would be able to meet redemptions. Instead the funds had to borrow millions to meet redemptions and, as a result, by mid-2000 the funds were suffering a cash flow crisis.

Amid ever-widening scandals in the $7 trillion fund industry, the SEC charges brought to light a new area of abuse that the agency said it has had under scrutiny for months. Also, a recent Reuters report noted that some bonds held in high-yield funds are not traded for days – or weeks – at a time and if their prices are not regularly adjusted or “fair valued” to better reflect their markets, they can be exploited by arbitrageurs.