The Securities and Exchange Commission on Wednesday ordered OppenheimerFunds Inc. and its sales and distribution arm to pay more than $35 million in fines for making misleading statements to investors about two company mutual funds struggling during the late-2008 credit crisis.
OppenheimerFunds, the agency said, used derivative instruments known as total return swaps to add substantial commercial mortgage-backed securities (CMBS) exposure in a high-yield bond fund called the Oppenheimer Champion Income Fund and in an intermediate-term, investment-grade portfolio called the Oppenheimer Core Bond Fund.
The SEC charged that Oppenheimer's 2008 prospectus for the Champion fund didn't adequately disclose the fund's practice of assuming substantial leverage in using derivative instruments. When the decline in the CMBS market left the swap contracts in both funds with large cash liabilities, forcing Oppenheimer to reduce its CMBS exposure, the firm disseminated misleading statements about the funds' losses and their recovery prospects, the SEC said.
Without admitting or denying the findings, OppenheimerFunds agreed to pay more than $35 million to settle the agency's charges. It will pay a penalty of $24 million, hand back $9.9 million in profits and pony up prejudgment interest of $1.5 million. The money will be deposited into a fund for the benefit of investors. The company was also censured.
Robert Khuzami, director of the SEC's Division of Enforcement, said mutual fund providers have an obligation to clearly and accurately convey the strategies and risks of the products they sell. "Candor, not wishful thinking, should drive communications with investors, particularly during times of market stress," he said.
According to the SEC's complaint, Oppenheimer's total return swaps gave its two funds substantial exposure to commercial mortgages without the purchase of 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 of both funds. These losses forced Oppenheimer to raise cash for month-end swap contract payments by selling securities into an increasingly illiquid market.
The agency also claims that the funds' portfolio managers, under instruction from senior management, began executing a plan in mid-November to reduce CMBS exposure. Just as they began, however, the now-collapsing CMBS market created staggering cash liabilities for the funds, driving their NAVs even lower.
The SEC's investigation found that continued CMBS declines forced the funds to sell more portfolio securities in order to raise cash for anticipated swap contract payments. This task became increasingly difficult for the Champion fund, ultimately prompting Oppenheimer to make a $150 million cash infusion into the fund on November 21, 2008. Over the next two weeks, the funds continued to reduce their CMBS exposure to avoid further losses.
Oppenheimer also made several misleading statements about the fund's problems, the SEC said. The company told both shareholders and financial advisors the funds had only suffered paper losses, but that investors' holdings and strategies remained intact. The company stressed that in lieu of actual defaults, the funds would continue collecting payments on the funds' bonds as the company waited for markets to recover.
The SEC claims these communications were 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 swap contract payments, resulting in realized investment losses and lost future income from the bonds.