Dechert's Financial Services Group writes in a new "OnPoint," a piece entitled, "SEC Charges an Investment Adviser and a Portfolio Manager with Fraud and Causing a Money Market Fund to Violate Rule 2a-7." The update, written by Jack Murphy, Stephen Cohen, and Brenden Carroll, explains, "The U.S. Securities and Exchange Commission (SEC) recently instituted public administrative and cease-and-desist proceedings against Ambassador Capital Management, LLC, a Detroit-based registered investment adviser (ACM), and one of its employees who served as the primary portfolio manager of the Ambassador Money Market Fund (Fund). The SEC alleges that ACM and the portfolio manager deceived the Fund's board of trustees (Board) and caused the Fund to violate Rule 2a-7 under the Investment Company Act of 1940 (1940 Act), the rule governing money market fund investments and operations." (See Crane Data's Nov. 27 News, "SEC Charges Ambassador Money Mkt. Fund Portfolio Manager With Fraud".)
It explains, "This OnPoint describes the role of the SEC's Division of Investment Management (Division) in uncovering the alleged fraud through an analytical review of the Fund's performance data and portfolio information. It then discusses the alleged fraudulent conduct and other alleged violations of the federal securities laws. Finally, the OnPoint suggests possible measures that can be taken to detect (and, perhaps, prevent) the types of conduct alleged by the SEC."
Under a section entitled, "Enhanced Analysis of Money Market Fund Data by the SEC's Division of Investment Management," Dechert writes, "According to the SEC press release, the enforcement action "stem[med] from an ongoing analysis of money market fund data by the SEC's Division of Investment Management, in this case a review of gross yield of funds as a marker of risk." The Order stated that, as of October 2011, the return of the Fund "significantly exceeded" the returns for prime money market funds in its peer group. Moreover, the Order noted that the Fund held, among other things, the securities of a non-U.S. issuer after it had been taken into receivership, as well as asset-backed commercial paper of a troubled German bank and two Italian issuers. These concerns prompted further examination by the SEC's Office of Compliance Inspections and Examinations (OCIE), which, after an on-site examination, referred the matter to the Asset Management Unit of the SEC's Division of Enforcement."
They add, "The SEC's press release credited the "ongoing quantitative and qualitative analysis of the asset management industry" by the Division's Risk and Examinations Office as playing a "vital role" in this enforcement action. Moreover, Norm Champ, the Division's Director, stated that "this [enforcement action] is an excellent example of how [the SEC's] investment in data analysis leads directly to investor protection." ... While the SEC Staff has long considered factors such as comparative fund performance when monitoring the money fund industry, the availability of these analytical tools, combined with the detailed data regarding the portfolio holdings of money market funds filed on Form N-MFP, has enhanced the ability of the SEC and its Staff to detect aberrational performance and to monitor the investments of money market funds and their compliance with Rule 2a-7."
Dechert says of the "SEC's Allegations Against ACM and the Portfolio Manager," "The SEC alleges that ACM and the portfolio manager violated the federal securities laws by repeatedly and knowingly making false or misleading statements to the Fund's Board regarding (i) the level of credit risk of the Fund's portfolio securities.... The Order also alleged that ACM had caused the Fund to violate certain requirements under Rule 2a-7, in addition to the failure to make required determinations that portfolio securities present minimal credit risks."
Among the "Lessons for Money Market Fund Advisers and Boards," the alert explains, "This enforcement action by the SEC clearly demonstrates what many in the industry had already realized -- that the increased transparency of money market fund portfolios due to website posting and filings of Form N-MFP, combined with the enhanced ability of the SEC Staff to analyze portfolio data and monitor for aberrational Fund performance, has dramatically increased the effectiveness of the Staff's oversight of money market funds."
Dechert adds, "As a result of this new level of efficiency (and to make sure that the SEC will not bring to their attention issues of which they are unaware), fund advisers may wish to review their compliance processes to assure themselves (and their funds' Boards) that: 1. any compliance issues that may arise under Rule 2a-7 will be identified and dealt with on a timely basis; 2. any fund performance that is materially higher than that of similar funds is promptly reviewed to ensure that such outperformance is not the result of investments that do not comply with Rule 2a-7, the fund's (and the adviser's) procedures under that rule or the investment parameters disclosed in the fund's prospectus and [SAI]."
Finally, they write, "In addition, money market fund advisers may wish to consider having their money market fund portfolio management team meet with the fund's Board to discuss the manner in which the fund is managed and the steps taken to assure that the fund is operated in compliance with Rule 2a-7. Although this enforcement action has not been settled and is part of an ongoing proceeding, the allegations made by the SEC and the manner in which the investigation was commenced are illustrative of the enhanced effectiveness of the SEC's ability to monitor the money market fund industry. In light of this, advisers and Boards should consider reexamining their policies, procedures and practices to ensure that their funds are being operated in compliance with applicable law."
