The SEC sought out hedge funds that reportedly delivered abnormal investment performance and, today, their efforts paid off with enforcement actions against 3 separate advisory firms and 6 individuals.  Each was charged with various misconduct, including improper use of fund assets, fraudulent valuations, and misrepresenting fund returns. Aberrational Performance Inquiry. The SEC Enforcement Division’s Asset Management Unit conducted the sweep investigation, using proprietary risk analytics to evaluate hedge fund returns, and ferret out funds with performances that seemed inconsistent with their investment strategies or other benchmarks. The charged firms and managers allegedly engaged in a wide variety of illegal practices in the management of hedge funds or private pooled investment vehicles, including:  (i) fraudulent valuation of portfolio holdings;  (ii) misuse of fund assets;  (iii) misrepresentations to investors about critical attributes such as performance, assets, liquidity, investment strategy, valuation procedures, and conflicts of interest.

“We’re using risk analytics and unconventional methods to help achieve the holy grail of securities law enforcement - earlier detection and prevention.  This approach, especially in the absence of a tip or complaint, minimizes both the number of victims and the amount of loss while increasing the chance of recovering funds and charging the perpetrators.” -- Robert Khuzami, Director of SEC Enforcement.

“The extraordinary returns reported by these advisers and portfolio managers were, in most cases, too good to be true.  In other cases, outlier returns were a telltale sign that something else was amiss.  We  are applying analytics across the investment adviser space - beyond performance and beyond hedge funds.”  --  Robert Kaplan and Bruce Karpati, Co-Chiefs of SEC Enforcement's Asset Management Unit.

Michael Balboa and Gilles De Charsonville. These 2 were charged by the SEC with engaging in a fraudulent scheme to overvalue the reported returns and NAV of the Millennium Global Emerging Credit Fund.  At its peak in October 2008, the hedge fund’s reported assets were $844 million. Michael Balboa, the fund’s former portfolio manager, allegedly schemed with 2 Euro-based brokers, including Gilles De Charsonville of BCP Securities LLC, to inflate the fund’s reported monthly returns and NAVs by manipulating its supposedly independent valuation process.  Separately, the U.S. Attorney’s Office in Manhattan announced the arrest of Balboa and simultaneous filing of a criminal action against him.

From at least January to October 2008, Balboa is alleged to have surreptitiously provided De Charsonville and another broker with fictional prices for 2 of the fund’s illiquid securities holdings for them to relate to the fund’s outside valuation agent and its auditor.  This caused the fund to be drastically overvalued by as much as $163 million in August 2008, which in turn fraudulently inflated the funds' reported monthly returns.

This served to attract at least $410 million in new investments, deter about $230 million in eligible redemptions, and generate millions of dollars in inflated management and performance fees.

SEC Staff Credits. The SEC’s investigation, which continues, was conducted by: Bill Conway, Brian Fitzpatrick, Alison Conn of the NYRO.  Nancy Brown is leading the s litigation effort.

ThinkStrategy Capital Management and Chetan Kapur. NY-based hedge fund firm ThinkStrategy Capital Management LLC and its sole MD Chetan Kapur were charged with fraud in connection with 2 separate hedge funds they managed - ThinkStrategy Capital Fund, TS Multi-Strategy Fund.  At its peak in 2008, ThinkStrategy managed about $520 million in assets.

ThinkStrategy and Kapur allegedly engaged in a pattern of deceptive conduct designed to bolster their track record, size, and credentials.   They materially overstated the performance of the Capital Fund and gave investors the false impression that the fund’s returns were consistently positive and minimally volatile.

ThinkStrategy and Kapur also repeatedly inflated firm assets, exaggerated the firm’s longevity and performance history, and misrepresented the size and credentials of firm’s management team.

ThinkStrategy and Kapur, by consenting to the entry of judgments, agreed to pay financial penalties and disgorgement in an amount to be determined by a federal court;  Kapur also was barred from the industry.

SEC Staff Credits. Investigation conducted by: Darren Long, Jeffrey Anderson, Scott Weisman.  Michael Semler is leading the remaining litigation effort.

Patrick Rooney and Solaris Management. Rooney and his company Solaris Management LLC were charged with fraudulently misusing the assets of the Solaris Opportunity Fund LP, which the firm managed.

Rooney and Solaris allegedly 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.

Rooney, who has been Chairman of Positron since 2004 and received salary and stock options from Positron since September 2005, allegedly misused the Solaris Fund’s money by investing more than $3.6 million in Positron through both private transactions and market purchases.  Many of the private transactions were undocumented while other investments were interest-free loans to Positron.  Rooney and Solaris hid the Positron investments and Rooney’s relationship with the company from the fund’s investors for over 4 years.  Although Rooney finally told investors about the Positron investments in a March 2009 newsletter, he allegedly lied by telling them he became Chairman to safeguard the fund’s investments.  These investments benefited 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.

SEC Staff Credits.   Investigation conducted by:  Andrew Shoenthal, Malinda Grish, Ann Tushaus, Linda Gerstman, Paul Montoya of the Chicago RO.  Timothy Leiman is leading the litigation effort.

LeadDog Capital Markets, Chris Messalas and Joseph LaRocco. Administrative proceeding were instituted against unregistered IA LeadDog Capital Markets LLC and its general partners and owners, Chris Messalas and Joseph LaRocco, who allegedly misrepresented or failed to disclose material information to investors in the LeadDog Capital LP fund.

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

They further allegedly misrepresented to, and concealed from, existing and prospective investors the substantial conflicts of interests and related party transactions that characterized the fund’s illiquid investments - e.g., to induce an elderly investor to invest $500K, in the fund, the three allegedly represented falsely that at least 1/2 of the fund’s assets were liquid and could be marked to market each day, and that the investor could exit the fund at any time.

SEC Staff Credits. Investigation conducted by:  Luke Fitzgerald, Lisa Knoop, James Flynn, Ken C. Joseph of the NYRO.  Richard Primoff is leading the litigation.

For further details and access to the SEC Complaint, go to:   [SEC PR 11-252, 12/1/11]