If it looks too good to be true, it is. That appears to be the stance that will be taken by the SEC when it comes to investigating the fraudulent activities of hedge fund advisors as evidenced by its recent enforcement action against three separate firms and six individuals.

The miconduct involved the improper use of fund assets, valuations and misrepresenting  fund returns.

The SEC calls its initiative  the Aberrational Performance Inquiry and says that its enforcement division's asset management unit, will rely on "proprietary risk analytics" to evaluate hedge fund returns.

But to one risk management expert contacted by Securities Technology Monitor it's nothing more than old-fashioned common sense. "They are really basing much of their theory on just how far off the performance of the hedge fund is to the overall market and its own strategy," says the risk management consultant in New York. "Hedge fund advisors pride themselves on generating alpha  but they can only do so much under the current market conditions."

The SEC's stance:  "Performance that appears inconsistent with a fund's investment strategy or other benchmarks forms a basis for further scrutiny," says the SEC in a statement.

The regulator went on to say that the "extraordinary returns" or outlier results provided by the hedge fund advisers were a "telltale sign" something was amiss. "We are using risk analytics and unconventional methods to help achieve the holy grail of securities law enforcement -- earlier detection and prevention," says Robert Khuzami, director of the SEC's Division of Enforcement."

Here are the highlights of the three cases. Fuller explanations can be found  on http://www.sec.gov/news/press/2011/2011-252.htm.

Michael Balboa and Gilles de Charsonville: The two individuals are charged in a fraudulent scheme to overvalue the reported  returns and net asset  value of the Millennium Global Emerging Credit Fund. 

The SEC's complaint says that Michael Bilboa, the fund's former portfolio manager plotted with  two European brokers including Gilles De Charsonville of BCP Securities to inflate the fund's reported monghtly returns and net asset value by manipulating its supposed independent valuation process. From at least January to October 2008, Balboa provided De Charsonville and another broker with fictional prices for two of hte fund's illiquid securities holdings for them to pass on to the fund's outside valuation agent and its auditor. The scam caused the fund to dramatically overvalue its securities holdings by as much as $163 million in August 2008 and the fund could then report "inflated and falsely positive monthly results."

ThinkStrategy Capital Management and Chetan Kapur: The SEC charged ThinkStrategy Capital Management and its sole managing director Chetan Kapur with fraud in connection with two separate hedge funds they mangaed. The SEC says that ThhinkStrategy and Kapur "materially overstated" the performance of the Capital Fund, exaggerated the firm's longevity and performance history and misrepresented the size and credentials of the firm's management team.

Patrick Rooney  and Solaris Management: The SEC charged Patrick Rooney and his company Solaris Management for fraudulently misusing the assets of the Solaris Opportunity Fund, to which it was the investment adviser. The SEC says that Rooney and Solaris made a radical change in the fund's investment strategy, contrary to the fund's offering documents and marketing materials, by becoming wholly invested in Positron Corp., a financially troubled microcap company. The investments benefitted Positron and Rooney while providing the fund with a concentrated, undiversified and illiquid position in a cash-poor company with a lengthy track record of losses.

LeadDog Capital Markets, Chris Messalas and Joseph LaRocco: The SEC instituted administrative proceedings agains unregistered investment adviser LeadDog Capital Markest and its general partners and owners Chris Messalas and Joseph LaRocco for misrepresenting or failing to disclose material informtaion to investors in the LeadDog Capital LP fund.

The SEC alleges that LeadDog, Messalas and LaRocco induced investors to invest in a hedge fund they controlled through material misrepresentations and omissions concerning among other things Messalas' negative regulatory history as a securities professional. compensation received by Messalas and LaRocco in connection with the fund's investments, and Messalas' substantial ownership interest in, and control of, some of the same companies to which he directed fund investments.  

Chris Kentouris writes for Securities Technology Monitor.


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