Lawrence Goldfarb, who runs SF-based fund manager Baystar Capital Mgmt, settled SEC charges that he concealed over $12 million in investment proceeds owed to investors of his Baystar Capital II, L.P.  He's alleged to have diverted "side pocketed" cash to other entities he controlled - and spent the money on a real estate venture and a record company.  He further is alleged to have comingled investor funds in a bank account used to pay for unauthorized personal expenses. 

Goldfarb and Baystar were able to carry out their fraud in part because the investment was maintained in a “side pocket” into which investors in the hedge fund had limited visibility.   [A Defining Moment:  A "side pocket" is a type of account that hedge funds use to separate particular investments that are typically illiquid from the remainder of the investments in the fund.]

Goldfarb’s side pocket investment became profitable in 2006, but he diverted the proceeds for other uses rather than paying the fund’s investors.  None of his transactions were authorized by the fund’s partnership agreement or offering documents.  Goldfarb agreed to pay more than $14 million to settle the SEC’s charges.

    According to SEC Complaint.   Goldfarb and Baystar concealed the fraud for several years by providing investors with false account statements showing no gains had been realized in the side pocket.  This falsely indicated that the side pocket investment had not yet distributed any profits to the fund, and investors were unable to determine that they were entitled to distributions.  Generally, investors can only withdraw their side pocket investments once the underlying position has been sold or liquidated. This helps ensure fairness by limiting the ability of an early-redeeming investor to withdraw a disproportionate share of the fund’s liquid assets.

Goldfarb also allegedly took steps to conceal the side pocket profits from the fund’s 3rd party administrator - e.g., he directed money to the bank account of an entity that no longer existed.

    Settled Fine and Sanction.   Goldfarb and Baystar agreed to permanent injunctions and to pay $12.1mn in disgorgement and $2mn in prejudgment interest - which will be distributed to fund investors - and a $130,000 penalty.  He's also barred from associating with any IA or BD and from participating in any offering of penny stock.

    SEC Staff Credits.   Investigated by Erin Schneider, Robert Leach - with SFRO and SEC’s Asset Mgmt unit.   For further details, go to:   [SEC PR 11-54, 3/1]