Macquarie Investment Management Business Trust (MIMBT) is set to pay a total of $79.8 million to settle charges with the Securities and Exchange Commission.
The registered investment adviser was charged with overvaluing approximately 4,900 largely illiquid collateralized mortgage obligations (CMOs) held in 20 advisory accounts, including 11 retail mutual funds, and for executing hundreds of cross-trades between advisory clients that favored certain clients over others.
Eric I. 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. Utilizing a third-party pricing service does not negate an investment adviser’s obligation to value assets accurately.”
Macquarie overvalued assets and imposed losses on retail funds
From January 2017 through April 2021, Macquarie 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.
Macquarie 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.
According to the SEC, Macquarie 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 the firm overstating the performance of client accounts holding the overvalued CMOs.
Macquarie then attempted to minimize losses to redeeming investors by arranging cross-trades with affiliated accounts, rather than selling the overvalued CMOs into the market, according to the SEC complaint, which points to one instance in which Macquarie executed 465 internal cross-trades between a selling account and 11 retail mutual funds above independent current market prices.
These cross-trades with affiliated accounts resulted in the retail mutual funds absorbing losses that otherwise would have been borne by the selling account in a market sale.
Macquarie was also found to have arranged for approximately 175 dealer-interposed cross trades in which the firm 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.
Macquarie agreed to pay a $70 million penalty and disgorgement and prejudgment interest, totaling an additional $9.8 million. The firm will also hire a compliance consultant to conduct a comprehensive review of its policies and procedures relating to, among other things, valuation of CMOs and associated liquidity risks, and cross-trading.
