WASHINGTON -- The Securities and Exchange Commission is investigating whether Piper Jaffray adequately disclosed the risks associated with derivatives to hundreds of investors in at least one of its mutual funds that suffered huge derivatives-related losses.

Officials with the Minneapolis-based investment company confirmed this week that SEC officials from Washington and Chicago have asked them for copies of annual and quarterly financial reports as well as the prospectus and sales materials given to investors of the Institutional Government Income Portfolio.

The fund, which investors claim Piper Jaffray had billed as a conservative, short-term government fund whose goal was the "preservation of capital," invested heavily in inverse floating-rate bonds and other risky and volatile derivative products whose value began plummeting earlier this year when interest rates rose.

As a result, the fund, which at its peak in late 1993 had assets of $825 million and paid $12 per share, now has assets of less than $600 million and is paying only $8 per share. Both Lipper Analytical Services in Summit, N.J., and Morningstar Mutual Funds in Chicago have ranked the fund at the bottom of their lists of almost 100 short-term government funds, with a decline in total return performance of roughly 22% over 12 months ending Aug. 31, 1994.

Investors across the nation, including some 60 Minnesota localities and pension funds, are still getting dividends but have seen the value of their principal drop precipitously.

Piper Jaffray officials say that the SEC officials are conducting a routine inquiry, not a formal investigation, and that they will ultimately find that Piper fully disclosed the derivatives risks to investors.

"We're not subject to any formal investigation or examination," said Charles Hayssen, the company's chief financial officer. "This is an inquiry and from our perspective it is reasonably routine.

"As of right now they have not found any fault," Hayssen said.

He said that while "it is true you can find parts of the prospectus that do not use the word 'derivatives' and warn you about them, there are other parts that do."

Analysts say the fund prospectus does contain some derivatives disclosures, but that it is always possible that the regulators or the courts might not view them as adequate.

The SEC inquiry comes as Minnesota securities regulators have begun an investigation of the fund and the New York State attorney general's office also may be probing it. In addition, investors have filed lawsuits against Piper to recover derivatives losses and competitors are suggesting Piper will not financially survive the controversy that is now threatening to spill over into its public finance business.

Piper officials and industry analysts, however, believe that Piper will be able to weather the storm.

The SEC inquiry may have stemmed from press reports about the Piper fund. However, at least one local official in Minnesota wrote to the SEC in July complaining that Piper did not adequately disclose the fund's derivatives risks.

In a letter to SEC commissioner Richard Roberts, Jon Elam, the city administrator for Maple Grove, Minn., said Piper never would have been, able to market the fund to investors if the investors had known the fund was heavily invested in inverse floaters and other derivatives.

Elam, whose city invested about $5 million in the fund and has lost about $1.5 million, or one-third of its principal amount, told Roberts that "thousands of investors" are relying on the SEC to make sure funds adequately disclose derivatives risks.

Roberts said he received the letter and passed it on to other SEC officials, whom he would not identify.

State securities regulators in the Minnesota department of commerce are conducting their own investigation of the funds' disclosures and derivatives losses, knowledgeable sources say.

Sources also say that the New York state attorney general is investigating the fund. But assistant attorney general William Mohr refused to comment on that yesterday, saying only, "We're investigating a number of funds that invested heavily in these exotic derivatives."

Two groups of investors have filed lawsuits against Piper, seeking to recover losses that resulted from derivatives-related losses. About 18 of Piper's 38 mutual funds have some derivatives holdings, Piper officials say.

The most recent lawsuit was filed in a federal court in Bridgeport, Conn., on behalf of investors in a fund sponsored by The Managers Funds, a Norwalk, Conn.-based investment company that had hired Piper to direct its investments, according to the Wall Street Journal. Officials with the funds group refused to comment on the suit.

But a suit that could potentially be even more damaging to Piper is one filed on behalf of all investors who invested in the Institutional Government Income Portfolio between July 1, 1991, and May 9, 1994.

The suit, which was filed in July in the U.S. Court for the District of Minnesota, Fourth Division, but has not yet been certified by the court as a class action suit, alleges that Piper made "materially misleading" statements and omitted key information from the fund prospectus and sales materials.

"This fund was marketed to investors as a very safe, conservative place to put their money where there was no risk of losing principal," said Gregg Fishbein, a lawyer with Schatz Paquin Lockridge Grindal & Holstein, the firm representing investors.

Fishbein also charged that the fund failed to follow its prospectus, which said the fund was prohibited from investing in securities that are not readily marketable.

Piper officials say the fund had about 7,000 shareholders, but it is not clear whether all of them were investing in the fund during the period addressed by the lawsuit.

Some investors and Piper's competitors believe the controversy and the lawsuits could sink the company financially.

"They don't have the resources to make everybody whole" if they lose those lawsuits, said Maple City's Elam.

Elam said he personally wants to see Piper put this controversy behind it and get the short-term government fund back on track. Investors have nothing to gain and can only be hurt by Piper's going out of business, he said.

Piper officials and fund analysts say Piper is not going under because of this controversy.

"Lots of securities firms get involved, regrettably, in Class action suits ... but things get worked out," said Hayssen. Everyone thought Salomon Brothers would go out of business because of the government securities scandal, but that did not happen, he said.

Piper is taking steps to restructure its short-term government fund and other funds that experienced derivatives losses, he said. The court case in Minnesota is not Scheduled to go to trial until December 1995, he noted, and anything could happen before then. Investors could recover some of their losses.

Michael Lipper, president of Lipper Analytical Services, said, "I think it's an extreme point of view that presumes that if there is a large enough settlement, that would wipe out the equity of the company."

Lipper said the market is not betting Piper will fall because its stock is priced between $9 and $10 per share, the same range as for other investment companies.

But the controversy has not helped Piper.

"Obviously, it's a disaster for Piper," said Don Phillips, publisher of Morningstar Mutual Funds. "It's a conservative, old-line firm that is shrouded in abysmal publicity that is wildly out of character for what its clients expected."

Last week it looked like Piper's investment problems might also spill over to its municipal bond business.

Piper is one of seven mostly Minnesota-based firms chosen to Underwrite three proposed bond issues, totaling more than $75 million, for a public buyout of the Target Center arena in Minneapolis. However, the Metropolitan Sports Facilities Commission, which would ultimately own the arena, has left the option open to remove Piper as co-manager of $42 million of bonds it plans to sell through the Metropolitan Council, an economic development agency in the Minneapolis-St. Paul area.

Bill Lester, the commission's executive director, said last week that in its approval last month of the financing team, the commission put in a provision allowing it to remove any firm with which it or the city of Minneapolis has an adversarial relationship.

According to Lester, that provision was due to the fact that the commission had lost $2 million in Piper's Institutional Government Income Portfolio and is contemplating suing the firm.

Frank Fairman, managing director of public finance at Piper, said the commission's action was the first to have the potential to affect the firm's public finance business.

"To this point we haven't lost any business to my knowledge as a result of [Piper's] institutional government fund," he said. Fairman pointed out that there were not a lot of government investors in the fund and that those governments that did invest in the fund did not make up a "large number" of Piper's public finance clients. "Is it something that we are monitoring and taking seriously so we don't lose public finance business? Yes," Fairman said. "Are we concerned that we will have large business losses? We haven't seen it yet."

He added that Piper's public finance business has been "very strong" this year.

Municipal bond sources said they've heard that some sales and trading people at Piper are beginning to look around for other jobs. Fairman said he is not aware that anyone has left Piper's municipal bond department.

The state of Florida has also suffered significant losses from Piper's overall derivatives activities, but state officials do not see these losses as a permanent setback.

The portion of Florida's fixed-income portfolio managed by Piper has fallen $127 million in market value from a peak of $477 million last fall to $350 million as of Aug. 30, according to Bruce Gillander, chief of the bureau of banking in the state treasurer's office. Gillander said he had not calculated the exact amount of the Piper losses attributable to derivatives, but estimated it accounted for "most" of the drop in market value.

"Piper had made aggressive investments in this area, particularly [collateralized mortgage obligations], and they got hit after the [Federal Reserve Board] changed policy in April," he said.

Over all, the Florida treasurer's office oversees $8.5 billion in state fixed-income investments, with about $3.1 billion managed by 24 private firms, including Piper, Gillander said. He noted that total loss of market value suffered this year on the outside-managed portion has been about $230 million. But Gillander said he does not see these losses as a problem. "We would prefer not to see a decline in market value, but it is not a real cause for concern here because, given our overall liquidity, we can hold these securities to maturity and they will pay off at par," he said. "There is no actual loss here."

Gillander also insisted that the income generated by the Piper portfolio outpaced that of the other 23 outside managers. According to the official, Piper's coupon return before trades was 9.8% so far in 1994, compared with about 7.5% for the other managers.

Gillander said that because of the controversy over the market losses, however, he is conducting a review of investment guidelines for outside managers. His recommendations, which will be submitted to state Treasurer Tom Gallagher in the next several weeks, could include limitations on "more volatile" collateralized mortgage obligations, he Said.

The Florida official also said that because of Piper's market losses, its Share of the state's portfolio will be reduced by one-quarter.

Karen Pietog and Donald Yacoe contributed to this article.

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