The SEC instituted proceedings against a private fund manager and its principals for inflating the valuation of illiquid assets and conflicts of interest. The SEC charges that the defendants marketed a fund with the term “income” in its name even though the fund held only illiquid assets including a private company and interests in gems and minerals. The SEC also asserts that the defendants inflated the values of the fund’s assets in order to pay their management fees while telling investors that the fund lacked liquidity to meet redemption requests. The SEC claims that the defendants illegally paid themselves more than $13 Million in management fees. The SEC also asserts that the principals engaged in self-dealing insider loan transactions and invested client money in their affiliated funds.
Fund sponsors claiming limited liquidity or redemption gates make want to re-consider how and when to pay management fees especially based on assets that are not publicly traded. Also, private fund sponsors should review fund names and offering documents to make sure they remain accurate over time.
The principal of a hedge fund manager was fined and barred from the industry, and his firm’s registration was revoked, for misusing soft dollar credits and cherry-picking trades. According to the SEC, the fund manager misused over $1.1 Million in soft dollar credits to pay such expenses as alimony to his ex-wife, inflated rent to an affiliated company, salary to an employee, and timeshare expenses. The SEC notes that such payments contradicted disclosures in the PPMs and the Form ADV. The SEC also charges the firm with engaging in an illicit cherry-picking scheme to enrich certain hedge fund clients over other clients.
We are seeing a renewed SEC interest in how firms use soft dollar credits. Although the facts of this case date back several years, this action may portend future regulatory and enforcement initiatives.
A direct lending platform agreed to pay a $4 Million fine and reimburse clients another $1 Million for allowing funds it managed to purchase loans in transactions that primarily benefited the parent company. The SEC also barred and fined the firm’s CEO and fined the firm’s CFO. The SEC asserts that the parent company used its controlling position on the Investment Policy Committee to force the funds to purchase loans outside its investment targets. The SEC accuses the firm of using the buying funds as a liquidity source following the loss of two major institutional investors. The SEC also maintains that the firm artificially inflated valuation and fund returns with undisclosed management adjustments. The SEC did not charge the parent company because it self-reported and cooperated and engaged in significant remediation efforts including establishing a new independent governing board, outsourcing valuation, and retaining a third-party compliance consultant.
OUR TAKE: It is very difficult to cure the conflict of interest inherent in self-dealing transactions where an operating company depends on managed private funds for liquidity, and the funds source their assets only from the parent company. This may be one of those conflicts that can’t be cured regardless of the disclosure.