A hedge fund manager agreed to pay over $4.7 Million in disgorgement, interest, and penalties for failing to prevent trading on material nonpublic information received from a political research firm. Although the respondent had strict policies about information provided by expert networks, the firm’s compliance policies had much lighter procedures for research firms, relying on employee self-monitoring and red flags. Nevertheless, the SEC asserts that the firm ignored red flags including the receipt of several pieces of material nonpublic information and the fact that the political intelligence analyst also served as the CCO. The SEC charges the firm with violating Section 204A of the Advisers Act, which requires the implementation of policies and procedures reasonably designed to prevent insider trading.
OUR TAKE: We call this “compliance voodoo” whereby a firm appears to write detailed compliance policies and procedures that allow behavior that the policies should be designed to prevent. In this case, there was no good reason to treat “research firms” different from “expert networks” when conducting insider trading due diligence.
The SEC has commenced civil enforcement proceedings against a hedge fund sponsor and its principals for failing to notify investors of its liquidity crisis and using improper transactions to pay redeeming investors. The Department of Justice has brought parallel criminal charges. According to the SEC, the respondents reported positive returns that averaged 17% per annum from 2003-2015. Additionally, the respondents assured investors that they would pay all redemptions within 90 days. The SEC alleges the firm inflated valuation of investments including 2 oil production companies, looted certain portfolio companies to pay redemptions, unlawfully transferred assets, and lied to auditors. As redemptions accelerated and the liquidity crisis grew, the SEC asserts that the respondents misled current and prospective investors about the funds’ valuation, liquidity and prospects. Ultimately, the funds ceased redemptions by placing most assets in an illiquid side pocket.
OUR TAKE: Compliance officers and due diligence professionals should review this complaint as a primer on private fund management misconduct. Red flags included consistent high performance, subjective valuations, conflicted transactions, and misrepresentations to auditors.