The Securities and Exchange Commission (SEC) has implemented a new program — called the Aberrational Performance Inquiry (API) — that has resulted in enforcement proceedings against three hedge funds for overstating material aspects of their business. API looks to find statements made by funds relating to its investment strategy, performance or size, and compares those claims to market data using proprietary analytical processes. In a statement, the SEC stated that API is being used to find the same type of misleading information from registered investment advisers, not just hedge funds.
“We’re using risk analytics and unconventional methods to help achieve the holy grail of securities law enforcement — earlier detection and prevention,” said Robert Khuzami, Director of the SEC’s Division of Enforcement, according to an SEC enforcement release. Robert Kaplan and Bruce Karpati, Co-Chiefs of the SEC Enforcement Division’s Asset Management Unit, added, “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.”
The SEC has filed enforcement actions to date based on information gleaned from API.
Three have been filed in federal court and one was brought as an administrative proceeding. Among them are:
1. A lawsuit alleging a fraudulent scheme to overvalue the reported returns and net asset value of the Millennium Global Emerging Credit Fund. At its peak in October 2008, the hedge fund’s reported assets were $844 million. The SEC’s complaint alleges that Michael Balboa, the fund’s former portfolio manager, conspired to inflate the fund’s reported monthly returns and net asset value by manipulating its supposedly independent valuation process. The U.S. Attorney’s Office for the Southern District of New York also arrested Balboa and filed a criminal action against him.
2. A lawsuit alleging that New York-based hedge fund firm ThinkStrategy Capital Management LLC and its sole managing director Chetan Kapur fraudulently engaged in a pattern of deceptive conduct designed to bolster their track record, size, and credentials by, among other things, drastically overstating the performance of the Capital Fund and lying to investors by claiming the fund’s returns were consistently positive and low-risk.
Kapur consented to the entry of an SEC order, instituted Nov. 30, 2011, barring him from the industry, while both he and the firm agreed to the entry of a consent order imposing civil penalties.
3. Another federal court lawsuit against Oakbrook, Ill. resident Patrick G. Rooney and his company Solaris Management LLC for fraudulently misusing the assets of the Solaris Opportunity Fund LP, to which Solaris served as the investment adviser. According to the SEC’s complaint, the fund abetted Rooney’s own self-dealing when it invested in a company in which he owned a significant interest, in violation of the fund’s stated investment policy.
4. An administrative proceeding against unregistered investment adviser LeadDog Capital Markets LLC and its general partners and owners Chris Messalas and Joseph LaRocco for misrepresenting or failing to disclose to investors in the LeadDog Capital LP fund his 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.
Parker MacIntyre is an Atlanta, Georgia-based law firm that regularly advises investment advisers and other financial professionals in matters involving compliance with their legal and regulatory obligations.