RIA Compliance Blog
A Denver-based alternative fund manager was recently charged by the Securities Exchange Commission (“SEC”) with engaging in fraudulent behavior regarding the handling of its futures fund, The Frontier Fund (“TFF”). The alternative fund manager, Equinox Fund Management LLC (“Equinox”), allegedly overcharged management fees to its investors and overvalued certain assets.
Equinox is registered as an investment adviser with the SEC and thus owes its investors certain fiduciary duties, one of which is to act in the best interests of its investors by being accurate and complete with its registration statements and SEC filings. Equinox, however, allegedly failed to meet those duties by misrepresenting in their TFF registration statements that management fees were based on the net asset value of the assets, when in reality they were based on the notional trading value of the assets. The notional trading value takes into account both the amount invested and the amount of leverage used in the underlying investments, and is significantly higher than net asset value.
This resulted in over-charges of $5.4 million over the course of seven years. Equinox was notified of a potential problem in early 2011 when independent auditors noticed the discrepancy and reported it to the Firm. Equinox responded by modifying TFF’s registration statement and Form 10-K, filed in late March, to disclose that Equinox charged management fees based on the notional trading value of the assets. However, it did not refund any of the additional management fees that they had received over the years by charging management fees on notational assets. The SEC determined that these additional management fees would have been material to TFF investors at the time of their investment decisions regarding TFF, and therefore should have been disclosed.
Equinox also allegedly misrepresented the value of certain assets to its investors. Specifically, in TFF’s Form 10-K for 2010 and various Form 10-Qs for 2011 Equinox allegedly stated that its valuation methodology was corroborated when it was not, and that an option was transferred in accordance with their valuation policies when it was not. In addition, Equinox allegedly failed to disclose in its third-quarter Form 10-Q that an option had been terminated early at a materially lower valuation than had previously been recorded. The SEC found that during the relevant period, from 2009 to 2011, Equinox had approximately 15,000 to 20,000 investors. In addition, it had between $800 million and $1 billion in net assets.
Equinox was charged with willful violations of Sections 17 of the Securities Act of 1933. It was also charged with causing TFF’s violations of Section 13(a) of the Securities Exchange Act of 1934 and certain rules thereunder. Equinox agreed to settle charges with the SEC and refund investors approximately $5.4 million in excessive management fees, as well as $600,000 in prejudgment interest. In addition, Equinox must pay a $400,000 penalty and must cease and desist from any further violations of federal securities laws.
In order to avoid situations such as this, fund managers should ensure that all registration statements and periodic filings with the SEC contain accurate information. Anything that could be potentially material to investors or could affect their decision-making process in any way should be disclosed. In addition, if an error is found, fund managers should take immediate corrective action including but not limited to amending their filings and refunding any overcharges.
Parker MacIntyre provides legal and compliance services to investment advisers, broker dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Visit our website for more information.