Opinion ID: 3160896
Heading Depth: 2
Heading Rank: 2

Heading: CIO Flannery

Text: Flannery joined SSgA in 1996 as a product engineer. In 2005, he became SSgA's Fixed Income CIO for the Americas. As CIO, Flannery had general supervisory oversight for SSgA's operations. However, he was not involved in the LDBF's investment decisions or its daily management. Flannery worked at SSgA until his position was eliminated in 2007. Before joining SSgA, Flannery had worked in the fixed-income area for about sixteen years, first in bond sales, then in managing fixed-income investments. He had an unblemished record in the industry and a reputation for being very honest and having a great deal of integrity. In May 2006, Flannery expressed that he was concerned about mortgage risk in the real estate market and requested SSgA's fixed-income team to provide him with an analysis on the subject. After the LDBF began underperforming in June 2007, Flannery requested on June 25, 2007, that members of SSgA's management team and a member of its risk team re-examine the subprime market. That day, the head of Global Structured Projects gave Flannery a memorandum that stated, [w]e remain constructive on the fundamentals and that foreclosures were lower than the 10-year - 10 - average except in California and the Rust Belt states. The memorandum indicated that we think there will be continued weakness in certain parts of the country . . . but we don't believe there is an imminent 'melt down' scenario. Subprime borrowers need loans, lenders are making loans, the street continues to fund these loans via the securitization market, and we expect this to continue going forward. By the end of July 2007, as the subprime crisis worsened, Flannery became personally involved with managing the LDBF and had daily contact with the SSgA risk team during the summer and fall of 2007. He filled in as chair at a July 25, 2007, SSgA Investment Committee meeting. According to meeting minutes, Flannery discussed two ways to provide liquidity if clients wanted to leave the LDBF: (1) by selling the LDBF's top-rated (AAA) bonds; or (2) by selling a pro-rata share of assets across the portfolio. Flannery noted that although AAA-rated bonds were liquid, if the liquidity gained from the sales were siphoned off, then they would be left with a lower quality portfolio. After discussion among the meeting's participants, the Investment Committee decided on an approach incorporating both options, where they would increase liquidity in the fund and sell a pro-rata share of assets to cover any withdrawals from the fund. The committee also agreed to reduce the LDBF's exposure to AA-rated assets. In the two days following the July 25 meeting, the portfolio management team sold about $1.6 - 11 - billion in AAA-rated bonds and $200 million in AA-rated bonds, which paid for investor redemptions and repurchase commitments. These transactions caused the LDBF's portfolio composition to change from approximately 48% investment in AAA-rated securities to less than 5%, and from 46% investment in AA-rated securities to more than 80%.
On August 2, 2007, Relationship Management sent a letter to clients in at least twenty-two fixed-income funds, signed by the individual Relationship Managers and including fund specific performance information. A draft of this letter had been sent to the legal department as well as several people to review. Flannery had also received a draft, and he made a number of edits, some of which stayed in the final version. However, Flannery had not been included on several e-mail exchanges related to edits on the letter prior to its distribution. The final version of the letter included the following paragraph: We believe that what has occurred in the subprime mortgage market to date this year has been more driven by liquidity and leverage issues than long term fundamentals. Additionally, the downdraft in valuations has had a significant impact on the risk profile of our portfolios, prompting us to take steps to seek to reduce risk across the affected portfolios. To date, in the Limited Duration Bond Strategy, we have reduced a significant portion of our BBB-rated securities and we have sold a significant amount of our AAA- rated cash positions. Additionally, AAA-rated - 12 - exposure has been reduced as some total return swaps rolled off at month end. Throughout this period, the Strategy has maintained and continues to be AA in average credit quality according to SSgA's internal portfolio analytics. The actions we have taken to date in the Limited Duration Bond Strategy simultaneously reduced risk in other SSgA active fixed income and active derivative- based strategies.
On August 14, 2007, Flannery sent a letter to LDBF investors, in an attempt to explain what was taking place in the housing-related securities market. Flannery was normally not responsible for client communications, and the Chief Executive Officer (CEO) of SSgA said it would not be a good idea, asking why Flannery would want to raise [his] head up. Flannery understood the CEO to be saying that this [was] kind of an ugly situation . . . why stand up and take a bullet, but Flannery wrote the letter because he thought it was the right thing to do. Flannery said that up to the limits that [he] was given by legal, [he] wanted to take responsibility for this disaster . . . and . . . to tell something of the arc of the story to put it in context. He said he wanted to be as just completely straightforward as [he] could be. The draft of the letter Flannery prepared included the following paragraph: The situation is extreme and difficult to manage. While we believe that the subprime markets clearly convey far greater risk than they have historically[,] we feel that forced - 13 - selling in this chaotic and illiquid market is unwise. Even if mortgage delinquencies soar beyond our expectations we would expect significantly higher values for our sub-prime holdings. While recent events may have repriced the risk of these assets for the foreseeable future and it is unlikely that they will retrace to values at the turn of the year we believe that liquidity will slowly re- enter the market and the segment will regain its footing. While we will continue to liquidate assets for our clients when they demand it, our advice is to hold the positions for now. The last sentence was then edited to read, While we will continue to liquidate assets for our clients when they demand it, our advice is to hold the positions in anticipation of greater liquidity in the months to come. Deputy General Counsel Mark Duggan revised that sentence to read, While we will continue to liquidate assets for our clients when they demand it, we believe that many judicious investors will hold the positions in anticipation of greater liquidity in the months to come. Flannery kept Duggan's change because Flannery believed both his original language and the revised language were accurate. In addition to Duggan, a number of people reviewed the letter, including the co-heads of Relationship Management, SSgA's president and CEO, and outside legal counsel.
In the Division's appeal of the ALJ's decision, the Commission held Flannery liable under Section 17(a)(3) for - 14 - misleading statements in both the August 2 and August 14 letters. With regard to the August 2 letter, the Commission found the statement that SSgA reduced its risk in part by selling a significant amount of its AAA-rated cash positions was misleading because LDBF's sale of the AAA-rated securities did not reduce risk in the fund. Rather, the sale ultimately increased both the fund's credit risk and its liquidity risk because the securities that remained in the fund had a lower credit rating and were less liquid than those that were sold. The Commission found that even if [Flannery] did suggest minor edits to the letter that were never incorporated, and even if others were 'heavily involved' in its drafting . . . those facts . . . do not excuse his decision to approve misleading language. With regard to the August 14 letter, the Commission found the many judicious investors language Duggan inserted was misleading because it suggested that SSgA viewed holding onto the LDBF investment as a 'judicious' decision when, in fact, officials at SSgA had taken a contrary view, redeeming SSgA's own shares in LDBF and advising SSgA advisory group clients to redeem their interests, as well. The Commission found that the misrepresentations in both letters were material and that Flannery acted negligently in both cases. The SEC went on to hold, as a matter of law, that two misstatements were sufficient to find a violation of Section 17(a)(3)'s prohibition on engag[ing] in any - 15 - . . . course of business which operates or would operate as a fraud or deceit upon the purchaser. We need not reach that issue of law.