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Private Fund Manager Took Management Fees While Telling Investors that Fund was Illiquid

 

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. 

Hedge Fund Manager Charged with Concealing Liquidity Crisis

frozen-money

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.

https://www.sec.gov/litigation/complaints/2016/comp-pr2016-267.pdf

SEC Adopts Liquidity Risk Management Program Rule

liquidity

The SEC has adopted a new rule requiring open-end registered funds to establish liquidity risk management programs.  New Rule 22e-4 will require registered funds to implement a program that assesses liquidity risk, classify securities into one of four liquidity categories, set a liquidity minimum, and report violations of overall portfolio illiquidity limits.  The liquidity risk program also requires Board oversight including the designation of a fund officer to administer the program.  The SEC also adopted new monthly portfolio disclosure rules for registered funds as well as a rule allowing funds to use swing pricing.  Fund complexes with more than $1 Billion in net assets must comply with the liquidity risk management rule by December 1, 2018.

OUR TAKE: The new rules will require a great deal of additional work for the folks in operations, legal and compliance.  The Oper-Pros will need to figure out how to pull and classify the data.  The lawyers will have to create additional disclosures.  And, the Compli-Pros will likely be the appointed officers to administer the programs.

https://www.sec.gov/news/pressrelease/2016-215.html