Similar troubles, different experiences

Heartland flourishes despite SEC charges; Strong struggles

By KATHLEEN GALLAGHER kgallagher@journalsentinel.com, Journal Sentinel

Thursday, December 25, 2003

Strong Capital Management Inc. and Heartland Advisors Inc. both stand accused of misdeeds, but they’ve had very different experiences when it comes to the timing of regulators’ actions and how they’re paying for their alleged transgressions.

The Securities and Exchange Commission filed a civil lawsuit earlier this month that accused Heartland of committing fraud by mispricing two troubled bond funds and alleged that certain company executives used inside information to dump shares in those funds before they slashed their value.

Even with the bond fund problems, Heartland has flourished in the three years since it marked down the bond funds.

The company has about $2.4 billion in assets, up from about $1 billion in the months following the Oct. 13 markdown of Heartland High Yield Municipal Bond Fund by 69% and Heartland Short Duration High Yield Fund by 44%.

Strong Capital Management hasn’t been so fortunate.

The Menomonee Falls firm has lost at least $3 billion in assets since September, when New York Attorney General Eliot Spitzer named Strong as one of four firms that gave a New Jersey hedge fund special opportunities to trade in certain of its funds that other shareholders didn’t have.

After Spitzer’s office said in October it planned to take action against Richard S. Strong personally on allegations of improper short-term trading of his company’s mutual funds, Strong resigned as the firm’s top executive and hired an investment banker to explore the sale of the company.

No charges have been filed against Strong or his company, and most of the information about the possible missteps has come from leaks to the media.

What’s taking so long?

How is it that it took three years for regulators to take action against Heartland for transgressions that appear much more serious than those that have Strong considering a sale of his company?

Some, like Thomas Peter von Bahr, say there’s no good explanation. The Lopez Island, Wash., resident was a shareholder in the Heartland bond funds, and said he would like to see criminal charges filed.

“I appreciate the effort the SEC attorneys made in bringing the civil charges, but the Heartland gang needs to be held accountable,” von Bahr said.

Congress has given the Justice Department, not the SEC, authority to file criminal charges. The U.S. Attorney’s office in Milwaukee is “monitoring the situation,” spokeswoman Elizabeth Makowski said.

While the SEC can’t file criminal charges, some wonder why it took so long to file the civil lawsuit.

“It turns out the activities at Heartland are perhaps more serious than we thought initially,” said Terence V. Pavlic, president of Pavlic Investment Advisors Inc., Brookfield, and a former governor for the Association for Investment Management and Research in Charlottesville, Va. “Why weren’t regulators on top of this two years ago? As an investor and someone in the business, I’d like to think we’d get to this quickly.”

Roy Weitz said he thinks of the SEC’s Heartland investigation as divided into two stages: pre-Spitzer and post-Spitzer.

“My guess is, up until September 3 (when Spitzer filed the lawsuit against Canary Capital Partners that launched the mutual fund scandal), the SEC was just doing their thing. It’s a pretty complicated case, and they figured they’d get to it in due time,” said Weitz, publisher of FundAlarm.com, an online newsletter that offers advice on which mutual funds to sell.

“My hope is, because the charges are so serious, maybe one of the reasons for the delay was they were trying to get all their ducks in a row and get their case as solid as possible for possible criminal prosecution.”

Heartland, for its part, says the charges are just that — not facts.

“These are allegations, these are not facts,” said Paul T. Beste, Heartland’s chief operating officer. “We believe that we’ve always operated consistent with SEC guidelines. Right now the matter is winding its way through the legal system, and we believe we’ll be vindicated at the end of the day.”

Spitzer spurs SEC

It’s not uncommon for the SEC to take as long as it did to file charges in the Heartland matter, said Mark C. Gardy, a partner at Abbey Gardy, a New York City law firm that represents plaintiffs in securities cases.

It’s still unreasonable, countered Eric Jacobson, a fund analyst at Morningstar Inc., Chicago. “A lot transpired between the blow-up and today that can’t be undone, such as a class action lawsuit that’s been signed, sealed and put to bed,” he said.

Most shareholders in the troubled Heartland bond funds settled with Heartland for a total of $14 million. The SEC lawsuit alleges investors lost $93 million.

“The Heartland case, while it might have been longer than normal, might have been viewed as the tradition or the norm in the industry,” said Geoffrey H. Bobroff, a mutual fund industry consultant at Bobroff Consulting Inc. in East Greenwich, R.I.

But Bobroff and Jacobson say that changed when Eliot Spitzer entered the picture.

“My impression is that the flurry of activity around Eliot Spitzer has a lot to do with the SEC’s actions,” Jacobson said.

Representatives from the SEC and Spitzer’s office declined to comment for this story.

Those two offices, though, have different authorities and different means of implementing them. The SEC can make rules, investigate and file civil charges. Spitzer can investigate, and file civil or criminal charges in cases with connections to New York.

Historically, the SEC has been more willing to use the enforcement process to complement its rule-making powers, Bobroff said. Spitzer wants to get to the meat of the problem, and do it quickly.

“I’m convinced the SEC and the Strong organization can reach a settlement in a timely way,” Bobroff said. “I’m not so sure Mr. Strong and the organization can reach a settlement with Spitzer.”

A changed environment

Other firms implicated in the mutual fund scandal have had more options, such as firing key people. That wouldn’t be as meaningful at Strong because Richard Strong owns about 90% of the firm.

“Selling the firm now gives them a chance to keep it intact and protect the value of the franchise,” Jacobson said.

While Strong is at least exploring selling his firm, Heartland has been expanding assets and proclaiming its innocence. In a letter to shareholders, Heartland’s founder and president, William J. Nasgovitz, said the bond fund problems occurred three years ago, the firm no longer manages those funds, and he did not engage in insider trading.

Still, the SEC lawsuit against Heartland will play out in an atmosphere that’s much changed from the one that existed when the bond fund problems arose, FundAlarm.com’s Weitz said.

“To some extent, they got a bye in the last three years. But now that it’s coming back in this environment, maybe they don’t realize things have changed,” he said. “When you fight in this environment, you’d better be right, because investors are going to make you pay.”