The SEC filed its third asset valuation action in recent
weeks. This time the proceeding named as Respondents eight mutual fund
directors for failing to properly oversee the valuation of assets in the funds
during the market crisis. In the Matter of J. Kenneth Alderman, CPA, Adm.
Proc. File No. 3-15127 (Filed December 10, 2012). Previously the Commission
brought similar actions against KCAP Financial and two executives at the firm
and Yorkville Advisors LLC and its officers. KCAP settled. The civil injunctive
action involving Yorkville, and the Alderman proceeding did not.
Six of the eight Respondents in Alderman are
independent directors and members of the audit committee of the funds: Jack
Blair; Albert Johnson; James Stillman McFadded; W. Randall Pittman; Mary Stone;
and Archie Willis. Also named were directors J. Kenneth Alderman and Allen
Morgan. The Funds involved were four closed end and one open ended fund. Each
had a board of directors composed of two interested and four independent
directors. All of the independent directors were members of the audit
committee, chaired by Respondent Stone. The investment adviser was Morgan Asset
At the end of the first quarter 2007 the Funds had a
combined net asset value of about $3.85 billion. Large portions of those assets
were invested in complex structured products such as collateralized debt
obligations and similar instruments. Those assets were concentrated in below
investment grade debt securities which carried inherent risks. For many of the
structured products there were no readily available market quotations. As a
result a large percentage of the Funds' portfolios had to be fair valued by the
Under the Policy and Procedure Manual for the Funds the
directors delegated to Morgan Asset the responsibility for carrying out certain
functions related to valuation of the portfolio securities in connection with
calculating the NAV per share. While the Funds' Valuation Procedures listed a
series of factors to be considered, many of which were drawn from the pertinent
literature, they provided no meaningful methodology or other specific direction
on how to make the fair value determination.
The actual task of assigning fair values on a daily based
was performed by Fund Accounting, a function staffed by Morgan Keegan
employees. In making their determinations of fair value, the Order alleges that
no reasonable analytical method was used.
Throughout the period the directors were unaware of the
methodology utilized by Fund Accounting and the Valuation Committee to fair
value the particular securities or types of securities. Likewise, they failed
to inquire about the methodology used.
As a result of the failure by the Directors to cause the
Funds to adopt and implement reasonable procedures, the NAVs of the Funds were
materially misstated from the end of March 2007 through early August of that
year. Thus the prices at which the open ended Fund sold, redeemed and
repurchased its shares were inaccurate. At least one registration statement,
and other filed reports, contained NAVs that were materially misstated. The
Form N-1A filed by the Select Fund for October 29 2007 that contained NAVs as
of June 30, 2007 that were materially overstated, according to the Order.
The Order alleges that the Respondents caused the Funds'
violations of Rules 22c-1, 30a-3(a) and 38a-1 of the Investment Company At of
1940. A hearing will be set in this matter.
Hurricane Sandy: As
we enjoy the holiday season please remember the victims of Sandy's destruction
with a donation to the Red Cross (here).
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a
blog by Thomas Gorman.
For more information about LexisNexis products
and solutions connect with us through our corporate site.