The US Securities and Exchange Commission (SEC) has imposed a penalty of $79.8m on registered investment adviser Macquarie Investment Management Business Trust (MIMBT) to settle charges of overvalued collateralised mortgage obligations (CMOs).
MIMBT overvalued around 4,900 CMOs, which were held in 20 advisory accounts, including 11 retail mutual funds.
The settlement also addresses allegations of executing hundreds of cross trades between advisory clients that supported certain clients over others.
SEC’s Miami Regional Office Director Eric Bustillo said: “It is alarming that a fiduciary took advantage of retail mutual funds it advised and executed unlawful cross trades to mitigate its overvaluation of fund assets.
“Utilising a third-party pricing service does not negate an investment adviser’s obligation to value assets accurately.”
According to the SEC’s findings, between January 2017 and April 2021, MIMBT managed the Absolute Return Mortgage-Backed Securities strategy.
It was a fixed-income investment strategy which included investments in mortgage-backed securities, CMOs, and treasury futures. Strategy investments comprised thousands of smaller-sized, “odd lot” CMO positions that traded at a discount to institutional, larger-sized positions.
The firm allegedly inflated the value of thousands of odd lot CMO positions using institutional-level pricing from a third-party service, despite the smaller size of these lots.
The SEC said that MIMBT had no rational basis to believe it could sell the odd lot CMOs at the pricing vendor’s valuations, resulting in MIMBT overstating the performance of client accounts holding the overvalued CMOs.
In addition, MIMBT arranged cross trades to minimise losses for redeeming investors by selling overvalued CMOs to affiliated accounts rather than to the open market.
In one instance, 465 internal cross trades were executed between a selling account and 11 mutual funds at inflated prices, transferring losses to the mutual funds.
Another 175 dealer-interposed cross trades involved the selling of odd lot CMO positions to third-party broker-dealers and then repurchasing those same positions for allocation to one or more affiliated client accounts.
This provided liquidity to redeeming investors often at above-market rates.
MIMBT has agreed to pay a $70m penalty along with $9.8m in disgorgement and prejudgment interest. The firm has also consented to certain undertakings, including retaining a compliance consultant to conduct a comprehensive review of its policies, valuation of CMOs and associated liquidity risks, and cross-trading.
