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OppenheimerFunds to pay USD35m to settle SEC charges


The Securities and Exchange Commission has charged investment management company OppenheimerFunds Inc and its sales and distribution arm with making misleading statements about two of its mutual funds struggling in the midst of the credit crisis in late 2008.

The SEC’s investigation found that Oppenheimer used derivative instruments known as total return swaps (TRS contracts) to add substantial commercial mortgage-backed securities (CMBS) exposure in a high-yield bond fund called the Oppenheimer Champion Income Fund and an intermediate-term, investment-grade fund called the Oppenheimer Core Bond Fund. The 2008 prospectus for the Champion fund didn’t adequately disclose the fund’s practice of assuming substantial leverage in using derivative instruments. And when declines in the CMBS market triggered large cash liabilities on the TRS contracts in both funds and forced Oppenheimer to reduce CMBS exposure, Oppenheimer disseminated misleading statements about the funds’ losses and their recovery prospects.

Oppenheimer agreed to pay more than USD35 million to settle the SEC’s charges.

“Mutual fund providers have an obligation to clearly and accurately convey the strategies and risks of the products they sell,” says Robert Khuzami (pictured), Director of the SEC’s Division of Enforcement. “Candor, not wishful thinking, should drive communications with investors, particularly during times of market stress.”
Julie Lutz, Associate Director of the SEC’s Denver Regional Office, added, “These Oppenheimer funds had to sell bonds at the worst possible time to raise cash for TRS contract payments and cut their CMBS exposure to limit future losses. Yet, the message that Oppenheimer conveyed to investors was that the funds were maintaining their positions and the losses were recoverable.”

According to the SEC’s order instituting settled administrative proceedings against OppenheimerFunds and OppenheimerFunds Distributor Inc., the TRS contracts allowed the two funds to gain substantial exposure to commercial mortgages without purchasing actual bonds. But they also created large amounts of leverage in the funds. Beginning in mid-September 2008, steep CMBS market declines drove down the net asset values (NAVs) of both funds. These losses forced Oppenheimer to raise cash for month-end TRS contract payments by selling securities into an increasingly illiquid market.

According to the SEC’s order, the funds’ portfolio managers under instruction from senior management began executing a plan in mid-November to reduce CMBS exposure. Just as they began to do so, however, the CMBS market collapse accelerated, creating staggering cash liabilities for the funds and driving their NAVs even lower.

The SEC’s order found that continued CMBS declines forced the funds to sell more portfolio securities in order to raise cash for anticipated TRS contract payments. This task became increasingly difficult for the Champion fund, ultimately prompting Oppenheimer to make a USD150 million cash infusion into the fund on 21 November. Over the next two weeks, the funds continued to reduce their CMBS exposure to avoid further losses.

According to the SEC’s order, Oppenheimer advanced several misleading messages when responding to questions in the midst of these events. For instance, Oppenheimer communicated to financial advisers (whose clients were invested in the funds) and fund shareholders directly that the funds had only suffered paper losses and their holdings and strategies remained intact. Oppenheimer also stressed that absent actual defaults, the funds would continue collecting payments on the funds’ bonds as they waited for markets to recover. These communications were materially misleading because the funds were committed to substantially reducing their CMBS exposure, which dampened their prospects for recovering CMBS-induced losses. Moreover, the funds had been forced to sell significant portions of their bond holdings to raise cash for anticipated TRS contract payments, resulting in realised investment losses and lost future income from the bonds.

The SEC’s investigation found that the Champion fund’s 2008 prospectus was materially misleading in describing the fund’s “main” investments in high-yield bonds without adequately disclosing the fund’s practice of assuming substantial leverage on top of those investments. While the prospectus disclosed that the fund “invested” in “swaps” and other derivatives “to try to enhance income or to try to manage investment risk,” it did not adequately disclose that the fund could use derivatives to such an extent that the fund’s total investment exposure could far exceed the value of its portfolio securities and, therefore, that its investment returns could depend primarily upon the performance of bonds that it did not own.

The SEC’s order finds that OppenheimerFunds violated Section 34(b) of the Investment Company Act of 1940, Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 (Securities Act), and Section 206(4) of the Investment Advisers Act of 1940 and Rule 205(4)-8 promulgated thereunder. The order finds that OppenheimerFunds Distributor violated Sections 17(a)(2) and 17(a)(3) of the Securities Act.

Without admitting or denying the SEC’s findings, OppenheimerFunds agreed to pay a penalty of USD24 million, disgorgement of USD9,879,706, and prejudgment interest of USD1,487,190. This money will be deposited into a fund for the benefit of investors. OppenheimerFunds and OppenheimerFunds Distributor also agreed to provisions in the order censuring them and directing them to cease and desist from committing or causing any violations or future violations of these statutes and rules.

The SEC’s investigation was conducted by Coates Lear, Jeffrey E Oraker, Hugh C Beck, Patricia E Foley, and Mary S Brady in the Denver Regional Office. The related examination of Oppenheimer was conducted by Francesco Spinella, Tracy O’Sullivan, C Michael Hooper, Kathleen A Raimondi, and Paula S Weisz under the supervision of branch chief Kenneth O’Connor and assistant director Dawn Blankenship in the New York Regional Office.

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