Investment adviser Macquarie Investment Management Business Trust (MIMBT) has been fined US$79.8 million for overvaluing around 4,900 largely illiquid collateralised mortgage obligations (CMOs).
The US Securities and Exchange Commission alleges MIMBT overvalued the CMOs held in 20 advisory accounts, including 11 retail mutual funds, and for executing hundreds of cross trades between advisory clients that favoured certain clients over others.
According to the SEC, from January 2017 through April 2021, MIMBT managed the Absolute Return Mortgage-Backed Securities strategy, a fixed-income investment strategy primarily invested in mortgage-backed securities, CMOs, and treasury futures.
Strategy investments included thousands of smaller-sized, “odd lot” CMO positions that traded at a discount to institutional, larger-sized positions. MIMBT valued the odd lot CMOs using prices obtained from a third-party pricing service that were intended for institutional lots only. The pricing service did not provide separate valuations for odd lots.
The SEC found that MIMBT had no reasonable basis to believe it could sell the odd lot CMOs at the pricing vendor’s valuations, and thousands of odd lot CMO positions were marked at inflated prices. This resulted in MIMBT overstating the performance of client accounts holding the overvalued CMOs.
MIMBT also attempted to minimise losses to redeeming investors by arranging cross trades with affiliated accounts, rather than selling the overvalued CMOs into the market. MIMBT also arranged for approximately 175 dealer-interposed cross trades in which MIMBT temporarily sold odd lot CMO positions to third-party broker-dealers and then repurchased those same positions for allocation to one or more affiliated client accounts, providing liquidity to redeeming investors in an otherwise illiquid market, often at above-market prices.
Eric Bustillo, director of the SEC’s Miami regional office, 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.”
The SEC found that MIMBT violated the antifraud and compliance provisions of the Investment Advisers Act of 1940, and certain provisions of the Investment Company Act of 1940.
MIMBT also agreed to retain a compliance consultant to conduct a review of its policies and procedures relating to, among other things, valuation of CMOs and associated liquidity risks, and cross trading.
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