The SEC settled an enforcement proceeding against a mutual fund investment adviser (the “Adviser”) for violations during the period 2001-2005 of certain investment restrictions (the “Restrictions”) that prohibited the Funds it advised (the “Funds”) from investing in companies that derive revenue from certain activities. The Funds held themselves out as socially responsible funds on the basis of the Restrictions, which were referenced in the Funds’ prospectuses, statements of additional information and other materials filed by the Funds with the SEC, and in communications to Fund shareholders and the Adviser’s reports to the Funds’ board. The SEC found that the Adviser had failed to comply with Restrictions, which, among other things, were to be enforced not only at the time a security was purchased but throughout the entire period that the security was held by a Fund. In addition, the Restrictions were fundamental, i.e., any amendment to a Restriction for a Fund was subject to a vote of the Fund’s shareholders.
Investment Screening - Policies and Practice. The SEC noted that the Adviser had adopted “screening” policies and procedures designed to enable it to enforce the Restrictions. The Adviser maintained a department responsible for “screening” companies for compliance with the Restrictions, and portfolio managers could purchase only securities that this department had screened for compliance with the Restrictions and approved for purchase. These policies, which were disclosed to the Funds’ board of directors, were not, however, consistently followed.
Additionally, the SEC noted that although the Registration Statements indicated that the Adviser continuously monitored each Fund’s portfolio for compliance with the Restrictions, the Adviser did not implement procedures addressing this claim until 2004, when it adopted a policy of screening every Fund holding once each six months, a policy with which the Adviser did not consistently comply. The SEC also found that until late 2005 the Adviser permitted portfolio managers to add to an existing position whether or not the holding had been screened within the preceding sixth-month period as required under the policy. The SEC noted that the Adviser reported regularly to the Funds’ board regarding divestments of securities that did not comply with the Restrictions, but failed in certain instances to note that the securities being divested had not complied with the Restrictions when purchased.
The settlement order provides a number of statistics regarding the violations found by the SEC, including the following : (1) from 2001 through 2005 the Adviser purchased ten securities (the “Restricted Purchases”) prohibited by the Restrictions for two of the funds; (2) six of the Restricted Purchases had been listed by the Adviser as having failed their most recent screen and the remaining four failed a screen conducted immediately after purchase; and (3) the Adviser failed to pre-screen approximately 8%, 16% and 5% of securities purchased for each of three Funds.
Remedial Action by the Adviser. The settlement order notes that in 2005 the Adviser took steps to enhance its compliance with the Restrictions by replacing certain senior management staff (including certain portfolio managers and the Chief Compliance Officer of the Funds), developing and distributing a new compliance manual and implementing new computer software to assist in compliance with the Restrictions.Violations and Sanctions. The SEC found that by failing to comply with the Restrictions the Adviser had (1) willfully violated Section 206(2) of the Advisers Act, which in general terms holds investment advisers to a non-scienter based anti-fraud standard in their conduct towards their clients, (2) caused the Fund’s violations of Section 13(a)(3) of the 1940 Act, which prohibits a fund from deviating from a fundamental policy including one identified in its prospectus or statement of additional information as such, and (3) willfully violated Section 34(b) of the 1940 Act, which, in relevant part, prohibits an untrue statement of a material fact in documents filed with the SEC. Under the terms of the settlement, the Adviser is subject to a cease and desist order and censure, and will be required to pay a civil money penalty of $500,000.