SEC Sanctions Macquarie Investment Management for Overvaluation and Cross-Trading Violations

In a recent enforcement action, theSecurities and Exchange Commission (SEC) sanctioned Macquarie Investment Management Business Trust (MIMBT) for significant violations involving asset valuation and cross-trading in its Absolute Return Mortgage-Backed Securities strategy. The SEC's findings highlight critical issues with MIMBT's valuation practices for illiquid securities, resulting in overstated performance reports and net asset values (NAVs). MIMBT's actions violated provisions of the Investment Advisers Act of 1940 and the Investment Company Act of 1940 , leading to a total settlement of $79.8 million in disgorgement, interest, and penalties.

Overview of Violations

From 2017 to 2021 , MIMBT used round-lot pricing marks to value illiquid, odd-lot mortgage-backed securities (CMOs), which inflated asset values and performance reports. Despite knowing that odd lots traded at a discount to round lots, MIMBT applied pricing marks designed for larger institutional trades, leading to inflated valuations across client accounts, including registered investment companies (RICs). Furthermore, MIMBT conducted improper cross-trades between client accounts at inflated prices, violating the SEC's rules on affiliated transactions and failing to disclose conflicts of interest.

The SEC found that MIMBT's actions breached its fiduciary duty, failed to follow pricing procedures, and resulted in unfair advantages for certain clients over others. MIMBT's misconduct misled investors by overstating liquidity and performance in marketing materials and regulatory filings.

Importance of Rule 2a-5 for Investment Companies

The SEC's action against MIMBT underscores the critical importance of Rule 2a-5 under the Investment Company Act of 1940, which governs the fair valuation of securities in registered investment companies (RICs). Effective September 2022, the ruleestablishes a framework to ensure that securities are valued in good faith based on current market conditions. Rule 2a-5 requires RICs to adopt robust valuation procedures, including regular testing of methodologies and oversight of pricing services, to ensure NAV accuracy and protect shareholders.

The MIMBT case highlights the risks of failing to comply with fair value requirements, particularly for illiquid securities where accurate market prices are harder to determine. The SEC emphasized that reliance on flawed pricing methods can harm investors by overstating NAV and performance, resulting in improper fees and misleading disclosures.

Takeaways for Fund Advisers

Investment advisers to registered funds must ensure that their valuation processes align with Rule 2a-5's requirements by:

• Using reliable market data to value securities, particularly illiquid ones, and avoiding speculative pricing practices.
• Monitoring third-party pricing services to ensure that prices reflect actual market conditions, particularly for non-standard trade sizes like odd lots.
• Providing transparent disclosures to investors about valuation risks, liquidity, and any conflicts of interest, particularly in marketing and performance reports.

The SEC's action against MIMBT serves as a reminder that improper valuation practices can lead to significant penalties and damage to investor trust. With Rule 2a-5 now in effect, fund boards and advisers must prioritize compliance to ensure accurate asset pricing and protect investors from the consequences of NAV inflation.

Read the SEC's order here.