Lance Brofman, a former principal of Fundamental Portfolio Advisors, a now defunct mutual fund group in New York, has been fined $250,000 by an SEC administrative law judge in New York and barred for life from associating with a broker/dealer, investment adviser or investment company.
Brofman's former company was also ordered to pay a $500,000 fine and Fundamental Service Corp., the fund group's distributor, was also fined $500,000. Registration of the two dormant firms was also revoked.
The Jan. 29 decision by Carol Fox Foelak, brings to a close an administrative action first brought by the SEC in September 1997.
It also follows a record $125,000 monetary sanction imposed by the National Association of Securities Dealers in March 1998. NASD charged that the fund group and its principals had widely distributed false and misleading fund marketing materials. The penalty was the largest that the NASD had ever levied on a company accused of fraudulent marketing and sales activities, NASD said. At that time, two other Fundamental Fund principals, Vincent J. Malanga and David P. Wieder, were also fined $100,000 and Malanga was suspended from the industry for 30 days.
The SEC originally charged Brofman with misrepresenting the level of risk of the Fundamental U.S. Government Strategic Income Fund, a no-load fund which was introduced in 1992 and was one of five mutual funds in the Fundamental Funds group.
The SEC alleged that from April 1992 to August 1994, Brofman marketed shares of the limited duration government- bond fund as a safe, stable investment when it was highly speculative and very risky. The fund's investors suffered considerable losses when interest rates rose several times in 1994 and the fund's net asset value declined by more than 30 percent, the SEC said.
The SEC alleged that the fund had used leverage and invested in highly volatile mortgage-backed derivatives securities called inverse floaters, which are very sensitive to changes in interest rates. The SEC claimed that neither the fund's prospectus nor its sales materials fully explained to potential investors the true volatility of the fund.
While the SEC said the fund did have disclosures relating to the fund's potential volatility, descriptions of the nature and extent of the risk were inadequate.
The SEC also found fault with how Brofman calculated the duration, or bond price volatility, of the fund's securities. The SEC charged that Brofman knowingly stated in fund literature that the fund would limit its investments to securities with an average weighted duration of three years or less, while the actual average duration of the fund's securities was much greater, thereby increasing the riskiness of the fund.
The SEC also alleged that the fund's executives failed to disclose a soft-dollar arrangement to the fund's board of directors. Under the arrangement, $670,921 was paid to two affiliated brokerage firms which provided interest rate research to the fund. The SEC charged that the wife of one of Malanga's business partners owned one of the firms. The board did not learn about the soft-dollar arrangement until May 1996, according to the SEC.
In issuing her opinion and sanctions, Judge Fox Foelak charged that Brofman's violations were "part of a pattern and were also flagrant and deliberate." Brofman had twice before been sanctioned by the SEC on fraud charges, dating back to 1984, she said.
"[Brofman's] disciplinary history and [his] evasive explanations concerning why he ignored the volatility of the inverse floaters and why FPA did not disclose its soft-dollar arrangements to the Fundamental Board indicate a lack of recognition of the wrongful nature of [the] conduct," said Judge Fox Foelak in her opinion. She also said that Brofman and the two firms were being expelled from the securities industry for the protection of investors.
Brofman said in a telephone interview that he disagreed with the SEC's decision and would appeal it.