How to Avoid Personal Liability? Involve Other Persons

BOSTON - Want to avoid personal liability in, for instance, properly valuing the assets in funds you manage?

Involve other persons in the process is the “simple answer,’’ legal analysts such as Todd Cipperman, principal of Cipperman Compliance Services, and Joanna Catalucci, managing director of compliance at Guggenheim Investments, say.

The trick is to create a “risk-based regime” inside your fund, according to Cipperman, that:

• Identifies where valuing assets can get difficult

• Develops a “carefully thought out process” for dealing with all factors involved

• Sets out a clear policy on how to come up with a value

• Implements that policy in procedures that can be followed

• Includes a “properly constituted” committee for finalizing the values and the procedures used to get them

• Includes portfolio managers, compliance officers, risk managers and other relevant executives and staff in that valuation committee

The involvement of a wide range of persons as well as clear procedure should immunize a fund manager from getting in the crosshairs of regulatrs, the analysts said at the NICSA general membership meerting here.

The key is to actually do the work, Catalucci said. If you’re a compliance officer, you may want to interview staff in different relevant functions to make sure they understand the procedures they’re responsible for and carrying them out properly.

The officer should attend valuation committee meetings and observe how the work happens. And the officer should document what happens, with minutes and by noting how frequently such meetings take place.

One good example of what should motivate portfolio managers to want to make sure there are policies, procedures and a functioning valuation committee is the 2011 Securities and Exchange Commission case brought against Morgan Asset Management and Morgan Keegan & Company, an investment advisory firm, the panelists said.

The two firms agreed to pay $200 million to settle charges that they were “falsely valuing” subprime mortgage-backed securities.

The Memphis-based firms, as well as former portfolio manager James C. Kelsoe Jr., and comptroller Joseph Thompson Weller were accused of causing false valuations of subprime mortgage-backed securities that were kept in five funds managed by Morgan Asset Management from January 2007 to July 2007. 

The SEC found that Morgan Keegan failed to employ reasonable pricing procedures and did not as a resultcalculate accurate “net asset values” for the funds.

Yet, Morgan Keegan nevertheless published the inaccurate daily net asset values and sold shares to investors based on the inflated prices.

But, in Cipperman’s summary, the grounds for personal liability in this case were the instances where Kelsoe, the portfolio manager, was allowed to override prices. Also adding risk: Leaving the pricing work to lower level employees, who then relied on the portfolio manager to make adjustments.

To avoid such liability, there should be no “element of cover-up” and, effectively, no unilateral actions. Or there has to be ‘reckless disregard’ for following procedure.

"There really have to be a lot of flags that were completely disregarded or a conscious effort" to pursue a hard-to-defend practice or valuation.

Usually, an individual will not be fined, if he or she takes a “collaborative approach” in coming up with valuations, said Tony Zacharski, a partner at the fund industry law firm Dechert.

Also key is finding support for the values chosen, such as broker quotes on the assets in question or recent sales of similar assets, noted Catalucci and Bruce Treff, managing director of Citi Fund Services.

In the end, “your valuation doesn't have to be right,’’ said Cipperman. “But you have to have a process.''