## Facts

- Mitchell Hutchins Asset Management Inc. (MHAM) was a registered investment adviser that served as the investment adviser to the PaineWebber Short-Term U.S. Government Income Fund (the fund), an open-end registered investment company.
- MHAM prepared the fund’s prospectus, which stated that the fund sought low volatility and would invest in U.S. government securities, including mortgage-backed securities (MBS).
- The prospectus represented that the fund had no intention of investing in MBS that did not protect against the risk of prepayment on the underlying mortgages (nonprotective MBS).
- Despite those statements, the fund’s portfolio manager repeatedly purchased nonprotective MBS, along with other instruments inconsistent with the fund’s disclosed low-volatility strategy, and MHAM did little to stop or correct the divergence from disclosure.
- MHAM had a procedure requiring portfolio managers to submit a monthly checklist addressing compliance with investment restrictions, but the first checklist for the fund was not submitted until nearly a year after the fund began operations.
- The fund’s custodian supplied daily pricing information for portfolio holdings.
- Fund procedures permitted the portfolio manager to override custodian-provided prices when the portfolio manager believed the custodian’s price did not reflect fair value.
- The portfolio manager made frequent price overrides and, in most instances, substituted higher prices that did not reflect the prices at which the securities could then be sold.
- The price overrides overstated the fund’s net asset value (NAV) and obscured the volatility associated with the fund’s holdings of nonprotective MBS.
- The portfolio manager did not keep records supporting the override price calculations, and MHAM did not adequately review the overrides or require adequate documentation.
- The SEC brought an administrative proceeding alleging that MHAM’s disclosure, valuation, and supervisory failures violated antifraud provisions of the federal securities laws and the Investment Advisers Act of 1940.

## Issues

1. Whether an investment adviser violates federal antifraud provisions when it prepares a fund prospectus stating the fund seeks low volatility and has no intention to invest in nonprotective MBS, yet permits portfolio management inconsistent with those statements without correcting disclosure.
2. Whether frequent, unsupported price overrides that inflate a mutual fund’s NAV and mask portfolio volatility constitute deceptive conduct under Securities Act § 17(a), Exchange Act § 10(b) and Rule 10b-5, and Advisers Act §§ 206(1) and 206(2).
3. Whether an adviser’s failure to implement and carry out compliance monitoring and supervision—such as delayed compliance checklists and inadequate review of valuation overrides—can support findings of adviser fraud and breach of fiduciary obligations under Advisers Act §§ 206(1) and (2).

## Decision

- The SEC instituted an административive enforcement proceeding against MHAM.
- The matter was resolved by Commission order (Investment Company Act Release No. 22805) based on MHAM’s settlement submission, without a hearing.
- The SEC found that MHAM violated:
  - Securities Act § 17(a);
  - Exchange Act § 10(b) and Rule 10b-5; and
  - Advisers Act §§ 206(1) and 206(2).
- The SEC concluded that the fund’s prospectus became materially misleading when the fund’s actual investments and risk profile diverged from the disclosed low-volatility approach and stated intention not to invest in nonprotective MBS.
- The SEC also found that MHAM’s oversight of valuation was deficient where the portfolio manager frequently overrode custodian prices to higher levels that did not reflect current sale prices, without supporting records and without adequate adviser review, resulting in overstated NAV and concealed volatility.
- The SEC ordered MHAM to cease and desist from committing or causing violations of the cited provisions and imposed sanctions and remedial relief, including requirements directed to valuation controls, documentation, and supervisory review.

## Legal Principles

- A fund prospectus must not contain materially misleading statements or omissions; disclosures about investment approach and risk can become misleading when actual portfolio practices materially differ and the adviser does not correct the resulting mismatch.
- An adviser that prepares or is responsible for disclosure documents can be liable under Securities Act § 17(a), Exchange Act § 10(b)/Rule 10b-5, and Advisers Act §§ 206(1)–(2) when misleading disclosure is combined with conduct that keeps investors unaware of the fund’s true risks.
- Mutual fund valuation practices can be deceptive when pricing methods produce NAV figures above realizable sale prices and thereby misstate value and conceal volatility.
- Fair-value determinations and any departures from third-party or custodian pricing should be supported by contemporaneous records and subject to meaningful review; unsupported, undocumented overrides increase the risk of overstated NAV.
- Written compliance procedures do not by themselves prevent violations; an adviser must implement monitoring and supervision that functions in practice, including timely compliance checks and review of key risk areas such as portfolio restrictions and valuation overrides.
- Under Advisers Act §§ 206(1) and (2), advisers owe fiduciary duties that require truthful disclosure and reasonable care in supervising activities that affect investor understanding of risk and the accuracy of reported fund values.

## Conclusion

In this SEC administrative order, the Commission found that Mitchell Hutchins Asset Management Inc. violated federal antifraud and adviser-fraud provisions by permitting portfolio investments inconsistent with the fund’s stated low-volatility approach and stated intention not to buy nonprotective MBS, and by failing to supervise and document frequent valuation overrides that inflated NAV and masked volatility; the SEC ordered cease-and-desist relief and sanctions with remedial measures focused on disclosure, valuation oversight, and supervision.


In the Matter of Mitchell Hutchins Asset Management Inc., Investment Company Act Release No. 22805 (1997)