The Games That Mutual Funds Play


OppenheimerFunds  Inc. has agreed to pay more than $35,000,000 to settle SEC charges that it  made misleading statements about two of its mutual funds during the credit crisis.  The payments include a penalty of $24,000,000, disgorgement of $9,879,706, and prejudgment interest of $1,487,190. According to the SEC, Oppenheimer used total return swaps (a type of derivative) to add significant leverage and commercial mortgage-backed securities (CMBS) exposure to two of its bond funds without purchasing actual bonds.  The funds involved were the Oppenheimer Champion Income Fund (a high-yield bond fund) and the Oppenheimer Core Bond Fund (an intermediate-term, investment-grade fund).

As a result of the collapsing CMBS market, staggeringly large payment obligations arose out of the swap contracts.  Oppenheimer was forced to sell portfolio securities into the collapsing market to raise cash to make those payments and reduce the funds’ CMBS exposure. Oppenheimer reportedly sought to mislead investors into believing that the funds were maintaining their positions, that the funds had only suffered paper losses, that their holdings and strategies remained intact, and that the losses could be recovered.

The SEC alleged that prospectus for the Champion fund failed to adequately disclose the substantial leverage that resulted from the swaps.  Instead, it provided an example of how boilerplate disclosures can be legally inadequate. The prospectus disclosed that the fund “invested” in “swaps” and other derivatives “to try to enhance income or to try to manage investment risk,” but it did not adequately disclose the magnitude of the derivatives exposure.  For example, the prospectus did not disclose that the fund’s total investment exposure could far exceed the value of its portfolio securities, or that its investment returns could be tied to the performance of bonds that it did not own.

The SEC also accused OppenheimerFunds of over-valuing one of the funds.  Marketing materials reportedly stated that the fund’s holdings of private equity funds were valued based on the manager’s estimates, when they were actually valued at a substantial mark-up of the estimates (“Oppenheimer & Co. to Pay Fine Over Fund,” by Gregory Zuckerman and Jean Eaglesham, Wall Street Journal).

Page Perry is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.