A private fund portfolio manager was barred from the industry and ordered to pay $749,000 in disgorgement and fines for intentionally inflating swap valuations and concealing his activities. According to the SEC, the PM, whose compensation was directly tied to fund performance, convinced management to use a discretionary valuation model for certain swaps and swaptions. Without telling management, he then began using discretionary inputs rather than default values for pricing. The SEC asserts that he used different discount curves to maximize valuations, fund performance, and his own compensation. The SEC further alleges that he hid his activities by lying to the fund administrator and third party brokers. Within 16 months after discovery of the mispricing, the firm reimbursed clients, shut down what had been a $375 Million fund, and ceased operations.
Firms should seriously re-consider tying portfolio management compensation directly to fund performance, especially where the PM is responsible for Level 3 (non-exchange traded) fair-valued securities. For both the C-suite and compli-pros, this case shows how a failure to properly supervise one bad employee can blow up your firm. As for the PM (and any other potential wrongdoer), the industry bar will make it difficult to find a job to get out of the six-figure hole resulting from the wrongdoing.