UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7626 / January 11, 1999 INVESTMENT COMPANY ACT OF 1940 Release No. 23639 / January 11, 1999 INVESTMENT ADVISERS ACT OF 1940 Release No. 1783 / January 11, 1999 ADMINISTRATIVE PROCEEDING File No. 3-9805 : ORDER INSTITUTING PUBLIC ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS AND CEASE-AND-DESIST ORDERS In the Matter of : : JOHN E. BACKLUND, JOHN : H. HANKINS, HOWARD : L. PETERSON, AND : JOHN G.GUFFEY, : : Respondents. : : I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that: A. public administrative proceedings pursuant to Section 9(b) of the Investment Company Act of 1940, as amended ("Investment Company Act") and Section 203(f) of the Investment Advisers Act of 1940, as amended ("Advisers Act"), and public cease-and-desist proceedings pursuant to Section 8A of the Securities Act of 1933, as amended ("Securities Act") and Section 9(f) of the Investment Company Act, be instituted against John E. Backlund ("Backlund"); and B. public administrative proceedings pursuant to Section 9(b) of the Investment Company Act, and public cease-and-desist proceedings pursuant to Section 8A of the Securities Act and Section 9(f) of the Investment Company Act, be instituted against John H. Hankins ("Hankins"), Howard L. Peterson ("Peterson"), and John G. Guffey ("Guffey"). II. In anticipation of the institution of these proceedings, Backlund, Hankins, Peterson, and Guffey ("Respondents") have submitted Offers of Settlement ("Offers") which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings contained herein, except the findings in: A. paragraphs III.A. and III.<> below, which Backlund admits; B. paragraphs III.A. and III.<> below, which Hankins admits; C. paragraphs III.A. and III.<> below, which Peterson admits; and D. paragraphs III.A. and III.<> below, which Guffey admits; Respondents, each of whom admits the Commission’s jurisdiction over him and over the subject matter of this proceeding, hereby consent to the entry of this Order Instituting Public Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and Cease-and-Desist Orders ("Order") making the findings and imposing the remedial sanctions set forth below. Accordingly, IT IS ORDERED that proceedings pursuant to Section 8A of the Securities Act, Sections 9(b) and 9(f) of the Investment Company Act, and Section 203(f) of the Advisers Act be, and they hereby are, instituted. III. On the basis of this Order and the Offers, the Commission makes the following findings: Background I. Community Bankers Mutual Fund, Inc. ("Community Bankers"), of Boston, Massachusetts, is a now-defunct open-end management investment company organized as a series company and offering a single series known as the U.S. Government Money Market Fund ("the Fund"). Community Bankers has been registered with the Commission since 1989. The Fund’s prospectus and Statement of Additional Information ("SAI") stated that it would attempt to maintain a constant net asset value ("NAV") of $1.00 per share. The Fund’s assets were valued at amortized cost, as permitted by Rule 2a-7 under the Investment Company Act. II. Community Assets Management, Inc. ("CAM"), a registered investment adviser since 1988, is owned by about 70 bank holding companies and state banks. From 1989 to 1994, CAM’s only client was Community Bankers. As investment adviser for the Fund, CAM made the day-to-day investment decisions for the Fund at all times except from May 1993 to July 1994, when a sub-adviser, Prospect Hill Advisers, Inc. ("Prospect Hill"), performed that function. CAM ceased operations in the fall of 1994, shortly after Community Bankers’ liquidation, but has not withdrawn its registration. III. Backlund, age 48, served as president and a director of both CAM and Community Bankers. Backlund managed CAM’s daily activities, including supervising CAM’s sales staff that marketed shares of the Fund. Prior to forming a sales staff, he made presentations to banks which were considering investing in the Fund. After forming the sales staff, Backlund personally prepared or approved the written sales materials distributed by them. All actions by CAM referred to herein were under Backlund’s direction and control. IV. Hankins, age 57, served as an independent director of Community Bankers from 1989 until its liquidation. He has been a practicing lawyer in West Virginia since 1966. V. Peterson, age 83, served as an independent director of Community Bankers from 1991 until its liquidation. He retired in 1975 as executive vice president of a local bank in Grand Island, Nebraska. Peterson was mayor of the city of Grand Island from 1964 to 1968, and a state senator in Nebraska from 1980 to 1984. VI. Guffey, age 50, served as an independent director of Community Bankers from 1990 until its liquidation. He has been a consultant to a mutual fund sponsor and is currently self-employed as a partner in a venture capital firm. VII. The Fund "broke the dollar" (i.e., failed to maintain a $1.00 per share NAV) as a result of having a substantial percentage (about 27½%) of its assets invested in adjustable-rate derivative securities that declined in value during mid-1994 due to rising interest rates. As a result, the Fund liquidated beginning September 26, 1994, eventually paying investors $0.961 per share. The total loss to shareholders was approximately $2.5 million. Purchase of Improper Investments VIII. CAM marketed Fund shares, targeting as investors for the Fund small community banks and their holding companies. CAM represented that an investment in the Fund was comparable, in safety and yield, to lending money at the Federal funds rate" the interest rate at which depository institutions’ (such as commercial banks’) deposits at Federal Reserve Banks may be lent overnight. CAM hired Prospect Hill as a consultant and later, in May 1993, the Fund’s shareholders elected Prospect Hill as sub-adviser to make the day-to-day investment decisions for the Fund. From February 1993 to March 1994, officers of Prospect Hill caused the Fund to acquire certain adjustable-rate derivative securities, called structured notes, for the Fund’s portfolio. By March 1994 approximately 27½% of the Fund’s net assets was invested in the structured notes. At this level, the structured notes were unsuitable for a money market fund because of the high risk that their market prices would fall substantially below their par values. IX. In late March 1994, after the Federal Reserve had raised the Federal funds rate for the second time in fewer than two months,[1] the structured notes became illiquid when many of the broker-dealers who made a market in them lowered their bids for the notes substantially or discontinued making a market in them altogether. As a result, the market value of the structured notes and the Fund’s portfolio value both decreased significantly. X. As the values of the structured notes fell, they became illiquid when they could no longer be sold within seven days at the price at which the Fund carried them. XI. After the structured notes dropped in value, CAM, with the knowledge and approval of the Community Bankers board, including Respondents, continued to market Fund shares to prospective and existing shareholders, representing to them that each Fund share continued to be worth $1.00 and that the Fund would not invest more than 10% of its assets in illiquid securities. Purchasers were unaware of the loss in value of the Fund’s portfolio securities, a loss in value known to the Community Bankers board. Fair Value Shadow Pricing Adopted XII. In late March or early April 1994, officers of Prospect Hill advised CAM that, due to interest-rate volatility, there were "anomalies" associated with determining market prices for the structured notes. Quoted spreads between bid and asked prices, which historically had ranged from 25 to 50 basis points, rose to between 200 and 400 basis points. At its April 12, 1994, meeting, as permitted by then Rule 2a-7(c)(6)(ii)(A),[2] the Community Bankers board amended its shadow pricing procedures to allow the use of fair value[3] as well as market quotations.[4] Use of fair value shadow pricing resulted in a claimed $1.00 NAV per share. The rule permits the substitution of the fair value of a security for the security’s market quotation for shadow- pricing purposes so long as the fair value reflects current market conditions. Use of fair value shadow pricing permitted the board to come to the conclusion that the amortized cost method continued to fairly reflect the market-based NAV per share. This, in turn, resulted in a claimed $1.00 NAV per share. Use of the old methodology (shadow pricing using market quotations) would have caused the board to conclude that the continued use of amortized cost no longer fairly reflected the market-based NAV per share, which would have required the board to mark to market under Rule 22c-1. The board knew at this meeting that the structured notes were illiquid but believed that the market anomaly was temporary. XIII. By June 1994, market bid prices of the structured notes indicated a total shortfall in portfolio value of about $2.1 million from the amortized cost of those securities. The Fund’s continued use of amortized cost and its fair value method of shadow pricing its portfolio, however, resulted in daily NAVs per share within the general range of $0.995 to $0.997, which the Fund then rounded up to $1.00 per share. About 27½% of the Fund’s $130 million in net assets, as of June 17, 1994, consisted of the structured notes, with par values totalling about $37 million. With the drop in market value of the structured notes, the overall value of the Fund’s portfolio fell proportionately. Knowledge of Respondents XIV. By the Community Bankers board meeting conducted June 17, 1994, fair value shadow pricing had been in use for a substantial length of time without any recovery in the market quotations for the structured notes. By that date also, the Federal funds rate had increased four times during 1994, twice while the Fund was using fair value shadow pricing. At Community Bankers’ previous board meeting, on May 10, 1994, Backlund advised the board that the structured notes would continue to be valued as they were "until market makers in these securities perceived that the Federal Reserve Board had moved away from its current credit- tightening posture." Also on May 10 the board: directed CAM and Prospect Hill to identify financial arrangements to be made should fair value shadow pricing be discontinued; stopped further purchases of structured notes; and directed Prospect Hill to reduce by $10 million the Fund’s current position of $37.5 million in structured notes. At the June 17, 1994, board meeting, officers of Prospect Hill gave their opinion that the market value of the structured notes likely would not revert to par until they had reached final maturity, years away; Prospect Hill also notified the board that it would resign as sub-adviser effective July 31, 1994. At the same meeting, the board: reviewed proposed solutions, including sale of the structured notes to the banks that owned CAM, or CAM borrowing from those banks to buy the structured notes at amortized cost; and directed CAM to attempt to obtain competitive quotes to facilitate orderly liquidation of the structured notes. Respondents were aware of the above facts by the time of the Community Bankers June 17, 1994, board meeting and as a result should have known that the continued use of the Fund’s fair value shadow pricing methodology was inappropriate. XV. At the June 17, 1994, board meeting Respondents knew: that the board needed to seek financial assistance for the Fund; and that the market conditions that caused the board to adopt fair value shadow pricing had been ongoing for a significant period of time with no change beneficial to the Fund and were continuing to adversely affect the Fund’s portfolio. As of June 17, 1994, the board had no reasonable basis for believing that the structured note valuation problem could be solved merely by the passage of time or that the adverse market conditions were temporary. After the June 17, 1994, board meeting: the Fund’s continued use of fair value shadow pricing was no longer appropriate because it did not reflect current market conditions; the board could no longer determine that the use of amortized cost to calculate the Fund’s NAV per share fairly reflected the Fund’s market-based NAV per share; and the board was required to calculate the Fund’s NAV per share pursuant to Rule 22c-1 under the Investment Company Act. Misleading Prospectus and SAI XVI. As a result of the foregoing, since at least the June 17, 1994, board meeting the Fund’s prospectus and SAI were materially misleading regarding (1) the liquidity of the Fund’s portfolio, and (2) the value of shares being sold. The SAI at all times stated that "no more than 10% of the Fund’s assets may be invested in repurchase agreements not terminable within seven days and other illiquid securities" (emphasis added). As noted, the structured notes, constituting about 27½% of the Fund’s assets, were being carried on the books of the Fund at a price substantially higher than the price at which they could be sold, according to available market quotations. They could not be sold within seven days at the price at which the Fund carried them and thus were illiquid. Also, the Fund was offering, selling and redeeming its shares at $1.00 per share, representing in its prospectus and otherwise that its NAV was $1.00 per share, when in reality, according to available market quotations for the structured notes, the NAV was less than $1.00 per share. XVII. On July 25, 1994, at the direction of its board, Community Bankers filed with the Commission a combined 1933-Act and 1940-Act registration statement (including a prospectus that had been amended by sticker on July 15), which once again made the material misrepresentations noted above regarding portfolio liquidity and NAV. XVIII. On September 26, 1994, the board recommended that Community Bankers’ shareholders approve the liquidation of the corporation. Violations XIX. Sections 17(a)(2) and 17(a)(3) of the Securities Act provide that it is unlawful for any person, directly or indirectly, in the offer or sale of securities, by the use of the means or instruments of transportation or communication in interstate commerce or by the use of the mails, (1) to obtain money or property by means of an untrue statement of a material fact or an omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (2) to engage in a transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser of such securities.[5] From about June 17, 1994 to about September 26, 1994, at the direction of the board, Fund shares were sold while omitting to disclose, or while making false and misleading disclosure of, material facts concerning: 1. the percentage of illiquid securities in the Fund’s portfolio; and 2. the value of the Fund’s shares being sold. Respondents, as members of the Fund’s board, should have known that the statements in the Fund’s prospectus and SAI were materially false and misleading as described above. Therefore, they willfully[6] violated Sections 17(a)(2) and 17(a)(3) of the Securities Act. XX. From about June 17, 1994, to about September 26, 1994, Respondents willfully aided and abetted and caused a violation of Rule 22c-1 under Section 22(c) of the Investment Company Act, in that, at the direction of the board, Fund shares were sold or redeemed at a price not based on the current net asset value of such shares which was next computed after receipt of a tender of such shares for redemption or of an order to purchase or sell such shares, by selling or redeeming Fund shares at a net asset value from about 1-1/2¢ to about 4¢ higher than the current net asset value based on market quotations for the Fund’s portfolio securities. XXI. On or about July 25, 1994, Respondents willfully violated Section 34(b) of the Investment Company Act, in that, at the direction of the board, a registration statement for Community Bankers was filed that made untrue statements of material facts, or omitted to state therein facts necessary in order to prevent the statements made, in the light of the circumstances under which they were made, from being materially misleading, by omitting to disclose, or by making false and misleading disclosure of, material facts concerning the matters set forth in paragraphs III.<>1. and III.<>2., above. IV. In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions specified by Respondents in their respective Offers. Accordingly, IT IS ORDERED that: A. Respondents Backlund, Hankins, Peterson, and Guffey cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act and Section 34(b) of the Investment Company Act, and from causing any violation of and any future violation of Rule 22c-1 under Section 22(c) of the Investment Company Act; B. Respondent Backlund shall, within ten days of the entry of this Order, pay a civil money penalty pursuant to Section 9(d)(2)(A) of the Investment Company Act, in the amount of $10,000 to the United States Treasury. Such payment shall be (A) made by United States postal money order, certified check, bank cashier’s check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (D) submitted under cover letter that identifies Backlund as a Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Daniel F. Shea, Securities and Exchange Commission, 1801 California St., Suite 4800, Denver, CO 80202; C. Respondents Hankins, Peterson, and Guffey shall, within ten days of the entry of this Order, each pay a civil money penalty pursuant to Section 9(d)(2)(A) of the Investment Company Act, in the amount of $5,000 to the United States Treasury. Such payment shall be (A) made by United States postal money order, certified check, bank cashier’s check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (D) submitted under cover letter that identifies Hankins, Peterson, or Guffey, respectively, as a Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Daniel F. Shea, Securities and Exchange Commission, 1801 California St., Suite 4800, Denver, CO 80202; and D. Beginning on the second Monday following entry of this Order, Respondent Backlund be, and he hereby is, suspended from association with any investment company or investment adviser for a period of twelve months. Backlund shall provide to the Commission, within 30 days after the end of the twelve-month suspension period described above, an affidavit that he has complied fully with the suspension described in this paragraph D. By the Commission. Jonathan G. Katz Secretary **FOOTNOTES** [1]: On February 4 the Federal Reserve had raised the rate from 3% to 3.25%; and, on March 22, from 3.25% to 3.5%. [2]: Now Rule 2a-7(c)(7)(ii)(A), see Investment Company Act Release No. 22921 (Dec. 3, 1997). [3]: It is permissible to shadow price securities under Rule 2a-7 using a fair value methodology, but the fair value shadow price must be determined "in good faith by the [investment company’s] board of directors." See Investment Company Act Section 2(a)(41). [4]: All of the Fund’s portfolio securities had previously been valued for shadow pricing by obtaining "quotations of value" from dealers in these securities. [5]: Scienter, the intent to deceive, manipulate, or defraud, is not an element of a Section 17(a)(2) or Section 17(a)(3) violation. Aaron v. SEC, 446 U.S. 680 (1980). Violations of these sections may be established by showing negligence. SEC v. Hughes Capital Corp., 124 F.3d 449, 453-54 (3d Cir. 1997); SEC v. Steadman, 967 F.2d 636, 643 n.5 (D.C. Cir. 1992). [6]: In applying the term "willful" in Commission administrative proceedings instituted pursuant to Section 9 of the Investment Company Act, the Commission evaluates on a case-by-case basis whether the Respondent knew or reasonably should have known under the particular facts and circumstances that his conduct was improper. In this case, as in all Commission administrative proceedings charging a willful violation under this statutory provision, the Commission applies this standard to persons " specifically, securities industry professionals " who are directly subject to Commission jurisdiction and who have a responsibility to understand their duties to the investing public and to comply with the applicable rules and regulations which govern their behavior.