[ by Howard Haykin ] The SEC, as expected, charged NY-based hedge fund adviser Philip Falcone and his advisory firm, Harbinger Capital Partners LLC for illicit conduct that included:  (i) misappropriation of client assets, (ii) market manipulation, (iii) betraying clients.  Also charged was Peter Jenson, ex-Harbinger COO, for aiding and abetting the misappropriation scheme.  The SEC reached a settlement with Harbinger for unlawful trading.  The SEC filed actions in U.S. District Court for the Southern District of New York. Harbert Management Corporation was charged in a separate, settled action;  Harbert affiliates allegedly served as the managing members of 2 Harbinger-related entities, and as a controlling person in the market manipulation. SEC Allegations. Falcone allegedly used fund assets to pay his taxes, conducted an illegal "short squeeze" to manipulate bond prices, secretly favored certain customers at the expense of others.  Harbinger is alleged to have unlawfully bought equity securities in a public offering, after having sold short the same security during a restricted period.

According to Robert Khuzami, SEC Director of Enforcement: "Today’s charges read like the final exam in a graduate school course in how to operate a hedge fund unlawfully.  Clients and market participants alike were victimized ... "

In particular, the SEC alleged that:

• Falcone fraudulently obtained $113 million from a hedge fund he managed, and misappropriated the proceeds to pay his personal taxes;

• Falcone and 2 Harbinger investment management entities, through which Falcone operated, manipulated the price and availability of a series of distressed high-yield bonds so as to engage in an illegal "short squeeze";

• Falcone and Harbinger secretly offered and granted favorable redemption and liquidity rights to certain strategically-important investors in exchange for those investors’ consent to restrict redemption rights of other fund investors, and concealed the arrangement from the fund’s directors and investors;

• Harbinger engaged in illegal trades in connection with the purchase of common stock in 3 public offerings after having sold the same securities short during a restricted period.

Describing the illegal short squeeze ... Gerald Hodgkins, Associate Director of SEC Enforcement, said, "After he took control of an entire issue of high-yield bonds, Falcone kept buying with an eye toward rigging the market and punishing short sellers to settle a score.  In the process, Falcone hijacked the market for the bonds and illegally manipulated their price and availability.  The Division will continue to police the bond market to make sure it operates as an efficient market, free of the corrosive effects of manipulators such as Falcone." Misappropriation Scheme. Here, it's alleged that Falcone unlawfully used fund assets to pay his personal taxes.  In 2009 Falcone owed federal and state authorities $113.2 million in taxes.  Declining to pursue other financing options, such as pledging his personal assets as collateral for a bank loan, Falcone elected instead to take a $113.2 million loan from the Harbinger Capital Partners Special Situations Fund, L.P. – even though Harbinger had earlier suspended investors from redeeming from this particular fund.

Falcone authorized the transfer of fund assets to himself, and Jensen helped structure the  transaction.  Falcone and Harbinger never sought or obtained consent from investors prior to using the fund's assets to benefit Falcone.

It's further alleged that Falcone and Harbinger, aided by Jenson, made several material misrepresentations and omissions in seeking legal advice regarding the loan and in subsequent communications with investors, including, among other things:

• financing alternatives available to Falcone;
• circumstances that led to Falcone’s need for the loan;
• ability of the Special Situations Fund to furnish the loan, without disadvantaging investors;
• terms and conditions of the loan, including rate of interest charged and amount of collateral posted by Falcone; and,
• role of Harbinger’s outside legal counsel in vetting the transaction.

Finally, it's alleged that Falcone and Harbinger delayed disclosing the loan for about 5 months because they were concerned that disclosure of Falcone’s financial condition might have a negative impact on investor withdrawals and on Falcone’s ability to attract more investments for other Harbinger funds.  Falcone repaid the loan in 2011, after the Commission commenced its investigation.

Market Manipulation / Illegal Short Squeeze. In a separate civil action, it's alleged that, from 2006 through early 2008, Falcone and 2 Harbinger investment management entities manipulated the market in a series of distressed high-yield bonds issued by MAAX Holdings Inc.  Here, Falcone and the entities allegedly orchestrated an illegal "short squeeze" - i.e., a market manipulation scheme in which an investor constricts the supply of a security, through large purchases or other means, with the intent of forcing settlement from short sellers at arbitrary and inflated prices.

Allegedly, at Falcone’s direction, Harbinger purchased a large position in the MAAX bonds during April and June of 2006.  After hearing rumors that a Wall Street financial services firm was shorting the MAAX bonds and also encouraging its customers to do the same, Falcone decided to seek revenge.  In September 2006, Falcone directed the Harbinger-managed funds to buy every available bond in the market, often purchasing the bonds from short sellers.  Ultimately, Falcone raised the funds’ stake to about 13% percent more than the available supply of the MAAX bonds.

At one point, Harbinger had purchased 22 million more bonds than MAAX had ever issued. Contemporaneously with these purchases, Falcone locked up the MAAX bonds that the Harbinger funds had purchased in a custodial account at a bank in Georgia to prevent his brokers from lending out the bonds to sellers seeking to deliver the bonds to purchasers after short sales.

Once allegedly in control of the supply of the MAAX bonds, Falcone then demanded that the Wall Street firm and its customers settle their outstanding MAAX short sales, not disclosing that it would be virtually impossible to find bonds available for delivery.  The Wall Street firm bid daily for the bonds, which quickly doubled in price.  Then, Falcone engaged in a series of transactions with certain short sellers at arbitrary, inflated prices, while at the same time valuing the funds’ holdings on his books at a small fraction of the prices he charged the covering short sellers. Preferential Redemption Scheme. In addition to alleged misappropriation, the SEC further alleges that Falcone and Harbinger, in a further breach of their fiduciary duties to their clients, engaged in unlawful preferential redemptions for the benefit of certain favored investors.

In 2009, while soliciting required investor approval to restrict withdrawals from another Harbinger fund, Falcone and Harbinger secretly exempted certain large investors that Falcone deemed to be strategically important from soon-to-be imposed liquidity restrictions - on the condition that those investors voted to approve restrictions that would temporarily stabilize the decline in Harbinger’s assets under management.

After securing the ‘vote buying’ agreements, Falcone and Harbinger allegedly permitted these investors - who were connected to certain favored institutional investors - to withdraw in total about $169 million.  The quid pro quo arrangements then were concealed from independent directors and fund investors.

Other Illegal Trading by Harbinger. Between April and June 2009, Harbinger allegedly violated Rule 105 under Reg. M, that prohibits short selling securities during a restricted period and then purchasing the same securities in a public offering.

To settle these SEC charges, Harbinger agreed to pay nearly $1.4 in disgorgement, prejudgment interest, and civil penalties.

Settlement with Harbert Management Company. In a separate complaint also filed in U.S. District Court for the Southern District of New York, the SEC filed a settled civil action against Harbert and 2 related investment entities - HMC-New York Inc. and HMC Investors, LLC – for their role in the illegal short squeeze described above.

During the entire period of the short squeeze, it's alleged that Harbert, HMC-NY and HMC Investors, directly or indirectly, possessed the power to control Falcone and the investment management entities through which he operated.  HMC-NY and HMC Investors, two entities controlled by Harbert, served as the managing members of 2 LLC's that acted as the general partners of the funds advised by Falcone.

Harbert and its affiliates also provided hedge fund administrative, legal, compliance, risk assessment and other services to the funds.  In these capacities, Harbert, HMC-NY and HMC Investors knew of Falcone’s trades in the MAAX bonds, but failed to take appropriate steps to address Falcone’s manipulative conduct.  The SEC charged the Harbert defendants as controlling persons pursuant to Section 20(a) of the Exchange Act, alleging that they are jointly and severally liable for Falcone’s and the Harbinger investment managers’ violations of the antifraud provisions of the Exchange Act.

To settle the SEC charges, Harbert, HMC-NY and HMC Investors agreed to pay $1 million in civil penalties - subject to approval by the court. Pending Federal Court Actions. In court actions concerning the first 3 fraudulent schemes described above, the SEC seeks a variety of sanctions and relief against Falcone and Harbinger from violations of the anti-fraud provisions of the Securities Act of 1933, the Exchange Act, and the Investment Advisers Act of 1940. The SEC seeks the following:   (i) to disgorge Falcone and Harbinger of ill-gotten gains, prejudgment interest, and civil money penalties;  (ii) to prohibit Falcone from serving as an officer and director of any public company;  (iii) to collect monetary penalties from Jenson and to enjoin him from aiding and abetting future violations of the anti-fraud provisions of the Exchange Act and Advisers Act. SEC Staff Credits. Investigation by SEC headquarters and NYRO staffers - including Conway Dodge, Jr., Robert Besse, Ken Joseph, Mark Salzberg, Brian Fitzpatrick and David Stoelting.  David Stoelting and David Gottesman will lead the litigation team. Contact the following for further info on: Misappropriation (loan) and preferential redemption case:

Bruce Karpati (212) 336-0104 Chief of the Asset Management Unit Division of Enforcement

Ken C. Joseph (212) 336-0097 Assistant Director, Asset Management Unit Division of Enforcement Market Manipulation (short squeeze) and Rule 105 cases:

Gerald W. Hodgkins (202)-551-4719 Associate Director Division of Enforcement

Conway T. Dodge (202) 551-4748 Assistant Director Division of Enforcement For further details, go to:  [SEC PR 12-122, 6/27/12], along with these SEC Complaints: 1.   SEC Complaint: Harbinger Capital Partners LLC; Philip Falcone; and Peter Jenson 2.   SEC Complaint: Philip Falcone, Harbinger Capital Partners Offshore Manager, LLC, Harbinger Capital Partners Special Situations GP, LLC. 3.  SEC Complaint: Harbert Mgmt Corp'n, HMC-New York, Inc., HMC Investors, LLC. 4.  SEC Administrative Proceeding.