Tag Archives: hedge fund due diligence

GAO Report Provides Insight into Potential Future Hedge Fund Regulation

1 Reply

As we have discussed previously, hedge funds, and the investment management industry, are likely to face increasing regulations in the future.  As we look toward Congressional testimony by hedge funds (see Congress to talk with Hedge Funds on November 12) and by other government officials, we have decided to look back at previous GAO reports to see what issues the GAO identified as important.

The U.S. Government Accountability Office has released two reports this year on hedge funds.  The first report (released in February of 2008) described the current hedge fund regulatory regime and some of the risks the current system posed.  The second report (released in September of 2008) focused on some of the issues which pension plans must consider when investing in hedge funds.  I’ve provided a brief overview of the objectives of the two studies below.

Additionally, this week we are going to examine the February report as it includes many of the issues which have surfaced because of the recent market events, especially with regard to counterparty risk.  A list of the topics we will discuss this week include (links activated as soon as articles are published):

The GAO Hedge Fund Reports

Hedge Funds: Regulators and Market Participants Are Taking Steps to Strengthen Market Discipline, but Continued Attention Is Needed

GAO-08-200 Released February 25, 2008  (for full report, please see PDF)

According to the preamble, “This report (1) describes how federal financial regulators oversee hedge fund-related activities under their existing authorities; (2) examines what measures investors, creditors, and counterparties have taken to impose market discipline on hedge funds; and (3) explores the potential for systemic risk from hedge fund-related activities and describes actions regulators have taken to address this risk.”

Defined Benefit Pension Plans: Guidance Needed to Better Inform Plans of the Challenges and Risks of Investing in Hedge Funds and Private Equity

GAO-08-692 Released September 10, 2008 (for full report, please see PDF please also see an earlier article we released on this report entitled Hedge Fund and Pension Report Issued by GAO)

GAO was asked to examine (1) the extent to which plans invest in hedge funds and private equity; (2) the potential benefits and challenges of hedge fund investments; (3) the potential benefits and challenges of private equity investments; and (4) what mechanisms regulate and monitor pension plan investments in hedge funds and private equity.

Other Related HFLB articles include:

Hedge Fund Stories and Analysis for the Week of October 5, 2008

Leave a reply

This past week has seen no shortage in the amount of articles on the hedge fund industry and the effect of the market and governmental events.  Below I’ve highlighted a few stories which I found particularly interesting and relevant for hedge fund managers.  Additionally, I think the following are points which hedge fund managers should be particularly aware of in light of recent events.

1. Hedge Fund Offering Documents are important. Most hedge fund offering documents are written very broadly and give the manager wide latitude in managing the fund.  The stories below highlight the important powers given to hedge fund managers.

2. Managers should start thinking of long term business continuity planning. While no one wants to think about and discuss what would happen during if the fund does have negative performance during the year, a well prepared manager will have a plan in place.  The stories below on blocked redemptions and re-negotiation of fees is showing us that managers were not prepared for the possibility of running a fund during lean times.  Managers should potentially think about retaining some performance fees in the management company so that they will be able to keep the doors open while trying to claw back to the high watermark.  Additionally, I believe that hedge fund due diligence will begin to include questions on how a manager would deal with a negative year.

Blocked Hedge Fund Withdrawals

A central concern for many market watchers (and investors) is whether hedge funds will have huge redemptions which would spark a sell off over the next couple of months.  We’ve seen some interesting items.  First, there is a fund which is actually blocking investor withdrawals in order to protect remaining investors from a fire sale of the fund’s assets (see story).

Restructure of Hedge Fund Performance Fees

As hedge fund managers see that the is the likliehood of negative returns this year, and the looming hedge fund high watermark provision, managers are rushing to cut deals with investors so that the funds can stay alive for the foreseeable future. According to a Wall Street Journal story, investors in the UK hedge fund RAB Capital agreed to “a three-year lockup in exchange for a management fee of 1% of assets and performance fee of 15% of returns, instead of 2% and 20%.”  The Stamford advocate reported that Camulos Capital LLC, a Greenwich-based hedge fund, and Ore Hill, a New York-based fund, among others, have restructured their fees to keep investors in their respective funds.

ABL Hedge Funds to step into the role of the banks?

If you listen to the news, and even the presidential candidates, you’ll hear about the “impending doom” in the banking industry – how mom and pop shops will not be able to get any loans to keep their business afloat.  While there have been many anectodes which suggest that this is, and is not, the case, it is likely that the banks will choose to pass on certain types of riskier loans, creating a great opportunity for non-traditional forms of finance.  Asset based lending is a hedge fund strategy in which the manager will make loans to business which will be backed by certain collateral, whether a receivable or some other physical asset.

I believe that we are going to see the launch of several asset based lending funds in the next few months and into the next year.  If the current banking climate remains how it is, asset based lending hedge funds might even become the next neighborhood banking center.  I have also previously written about the popularity of asset based lending hedge funds.

Hedge Fund Due Diligence 2.0

4 Replies

We hear about the “web 2.0” and today’s San Francisco Chronicle used the term “Wall Street 2.0” which made me wonder what the hedge fund industry will look like after this mess clears itself over the next couple of months.  First, it is obvious that there is going to be government regulation of some sort over the hedge fund industry which I will be detailing over the coming weeks and months.  Additionally, investors are going to need to take proactive steps to protect their investments and hedge fund due diligence will become a greater part of the hedge fund industry – I’m dubbing this “Hedge Fund Due Diligence 2.0”.

Hedge Fund Due Diligence 2.0 is likely to include more questions on the hedge fund manager’s business acumen and operations.  The current crisis has showed us, in numerous circumstances, that hedge fund managers were simply not prepared to handle a complete market crisis.  Hedge fund managers already have to answer in depth questions relating to risk management policies and procedures, but these questions will likely become more in depth.  Specifically, Hedge Fund Due Diligence 2.0 will likely inquire into a manager’s specific cash management policies.  While this might be viewed as digging into the manager’s operational business (as opposed to just the managers performance results), it is necessary to protect an investor’s investment in the event that a high watermark provision is implicated.

More to come on this topic …

Hedge Fund and Pension Report Issued by GAO

5 Replies

On Wednesday the U.S. Government Accountability Office (“GAO”) released a report examining investments by defined benefit pension plans into hedge funds. The report is titled: Defined Benefit Pension Plans: Guidance Needed to Better Inform Plans of the Challenges and Risks of Investing in Hedge Funds and Private Equity. To produce the report, the GAO talked with hedge fund instry associations, government administrative entities and both private and public pension funds. Some of the private pensions interviewed include: American Airlines, Boeing, Exxon Mobil, John Deere, Macy’s and Target. Some of the public pensions included: CalPERS, New York State Common Retirement Fund and the Washington State Investment Board.

I had a chance to read through the 65 page report and found it to be very well written and researched. The report also accurately and succinctly summarizes the applicable laws and regulations which apply to pensions investing in hedge fund and private equity funds. Overall I think that the report contains a good deal of very useful information. For start up hedge fund managers looking to eventually raise money from institutional investors, the report should be required reading. Some of the more salient points raised in the report include:

  • pension plans investments into hedge funds is expect to continue to increase
  • pension plans are aware of the risks of investing in hedge funds including: liquidity risk, transparency risk, valuation risk (potentially), high fees, and leverage
  • pension plans are not afraid to pull money from non-performing hedge funds; however, hedge fund managers should not focus on investment ideas at the expense of operational considerations
  • due diligence will become more important as time goes on (and as more frauds are caught)

Below I have produced (what I view are) the most useful or intersting parts of the report. The headings and the emphasis in the text below, along with all information in brackets, are my own. Any footnotes have been omitted. The entire report can be found here.

Background and purpose of the report

Millions of retired Americans rely on defined benefit pension plans for their financial well-being. Recent reports have noted that some plans are investing in ‘alternative’ investments such as hedge funds and private equity funds. This has raised concerns, given that these two types of investments have qualified for exemptions from federal regulations, and could present more risk to retirement assets than traditional investments.

To better understand this trend and its implications, GAO was asked to examine (1) the extent to which plans invest in hedge funds and private equity; (2) the potential benefits and challenges of hedge fund investments; (3) the potential benefits and challenges of private equity investments; and (4) what mechanisms regulate and monitor pension plan investments in hedge funds and private equity.
GAO recommends that the Secretary of Labor provide guidance on investing in hedge funds and private equity that describes steps plans should take to address the challenges and risks of these investments. Labor generally agreed with our findings and recommendation.

Hedge fund definition

While there is no statutory definition of hedge funds, the phrase “hedge fund” is commonly used to refer to a pooled investment vehicle that is privately organized and administered by professional managers, and that often engages in active trading of various types of securities and commodity futures and options contracts. Similarly, private equity funds are not statutorily defined, but are generally considered privately managed investment pools administered by professional managers, who typically make long-term investments in private companies, taking a controlling interest with the aim of increasing the value of these companies through such strategies as improved operations or developing new products. Both hedge funds and private equity funds may be managed so as to be exempt from certain aspects of federal securities law and regulation that apply to other investment pools such as mutual funds.

Description of pension plan investment into hedge funds

Pension plans invest in hedge funds to obtain various benefits, but some characteristics of hedge funds also pose challenges that demand greater expertise and effort than more traditional investments, which some plans may not be able to fully address. Pension plans told us that they invest in hedge funds in order to achieve one or more of several goals, including steadier, less volatile returns, obtaining returns greater than those expected in the stock market, or diversification of portfolio investments. Pension plan officials we spoke with about hedge fund investments all said these investments had generally met or exceeded expectations. However, at the time of our contact in 2007, several plan officials noted that their hedge fund investments had not yet been tested under stressful economic conditions, such as a significant stock market decline. Further, some indicated mixed experiences with hedge fund investments. At the time of our discussions, however, officials of each plan interviewed indicated that they expected to maintain or increase the share of assets invested in hedge funds.

Nonetheless, hedge fund investments pose investment challenges beyond those posed by traditional investments in stocks and bonds. These additional challenges include: (1) the inherent risks of relying on the skill and techniques of the hedge fund manager; (2) limited information on a hedge fund’s underlying assets and valuation (limited transparency); (3) contract provisions which limit an investor’s ability to redeem an investment in a hedge fund for a defined period of time (limited liquidity); and 4) the possibility that a hedge fund’s active or risky trading activity will result in losses due to operational failure such as trading errors or outright fraud (operational risk). Although there are challenges of hedge fund investing, plan officials and others described steps to address these and other challenges. For example, plan officials and others told us that it is important to negotiate key investment terms and conduct a thorough “due diligence” review of prospective hedge funds, including review of a hedge fund’s operational structure. Further, pension plans can invest in funds of hedge funds, which charge additional fees but provide diversification and the additional skill of the fund of funds manager. According to plan officials and others, some of these steps require considerably greater effort and expertise from fiduciaries than is required for more traditional investments, and such steps may be beyond the capabilities of some pension plans, particularly smaller ones.

ERISA considerations

Under the Employee Retirement and Income Security Act (ERISA), plan fiduciaries are expected to meet general standards of prudent investing and no specific restrictions on investments in hedge funds or private equity have been established. Labor [the DOL] is tasked with helping to ensure plan sponsors meet their fiduciary duties; however, it does not currently provide any guidance specific to pension plan investments in hedge funds or private equity. Conversely, some states do specifically regulate and monitor public sector pension investment in hedge funds and private equity, but these approaches vary from state to state. While states generally have adopted a “prudent man” standard similar to that in ERISA, some states also explicitly restrict or prohibit pension plan investment in hedge funds or private equity. For instance, in Massachusetts, the agency overseeing public plans will not permit plans with less than $250 million in total assets to invest directly in hedge funds. Some states have detailed lists of authorized investments that exclude hedge funds and/or private equity. Other states may limit investment in certain investment vehicles or trading strategies employed by hedge fund or private equity fund managers. While some guidance exists for hedge fund investors, specific guidance aimed at pension plans could serve as an additional tool for plan fiduciaries when assessing whether and to what degree hedge funds would be a prudent investment.

… all [the pension plans] said that their hedge fund investments had generally met or exceeded expectations, although some noted mixed experiences. For example, one plan explained that it had dropped some hedge fund investments because they had not performed at or above the S&P 500 benchmark. Also, this plan redeemed its investment from other funds because they began to deviate from their initial trading strategy.

Challenges and risks of hedge fund investments

While any plan investment may fail to deliver expected returns over time, hedge fund investments pose investment challenges beyond those posed by traditional investments. These include (1) reliance on the skill of hedge fund managers, who often have broad latitude to engage in complex investment techniques that can involve various financial instruments in various financial markets; (2) use of leverage, which amplifies both potential gains and losses; and (3) higher fees, which require a plan to earn a higher gross return to achieve a higher net return.

Hedge Fund Fees

Several pension plans cited the costly fee structure fees as a major drawback to hedge fund investing. For example, representatives of one plan that had not invested in hedge funds said that they are focused on minimizing transaction costs of their investment program, and the hedge fund fee structure would likely not be worth the expense. On the other hand, an official of another plan noted that, as long as hedge funds add value net of fees, they found the higher fees acceptable.

Operational Risk

Pension plans investing in hedge funds are also exposed to operational risk—that is, the risk of investment loss due not to a faulty investment strategy, but from inadequate or failed internal processes, people, and systems, or problems with external service providers. Operational problems can arise from a number of sources, including inexperienced operations personnel, inadequate internal controls, lack of compliance standards and enforcement, errors in analyzing, trading, or recording positions, or outright fraud. According to a report by an investment consulting firm, because many hedge funds engage in active, complex, and sometimes heavily leveraged trading, a failure of operational functions such as processing or clearing one or more trades may have grave consequences for the overall position of the hedge fund. Concerns about some operational issues were noted by SEC in a 2003 report on the implications of the growth of hedge funds. For example, the 2003 report noted that SEC had instituted a significant and growing number of enforcement actions involving hedge fund fraud in the preceding 5 years. Further, SEC noted that while some hedge funds had adopted sound internal controls and compliance practices, in many other cases, controls may be very informal, and may not be adequate for the amount of assets under management. Similarly, a recent Bank of New York paper noted that the type and quality of operational environments can vary widely among hedge funds, and investors cannot simply assume that a hedge fund has an operational infrastructure sufficient to protect shareholder assets.

Several pension plans we contacted also expressed concerns about operational risk. For example, one plan official noted that the consequences of operational failure are larger in hedge fund investing than in conventional investing. For example, the official said a failed long trade in conventional investing has relatively limited consequences, but a failed trade that is leveraged five times is much more consequential. Representatives of another plan noted that back office and operational issues became deal breakers in some cases. For example, they said one fund of funds looked like a very good investment, but concerns were raised during the due diligence process. These officials noted, for example, the importance of a clear separation of the investment functions and the operations and compliance functions of the fund. One official added that some hedge funds and funds of funds are focused on investment ideas at the expense of important operations components of the fund.

Importance of hedge fund due diligence

Pension plans take steps to mitigate the challenges of hedge fund investing through an in-depth due diligence and ongoing monitoring process. While plans conduct due diligence reviews of other investments as well, such reviews are especially important when making hedge fund investments, because of hedge funds’ complex investment strategies, the often small size of hedge funds, and their more lightly regulated nature, among other reasons. Due diligence can be a wide-ranging process that includes a review and study of the hedge fund’s investment process, valuation, and risk management. The due diligence process can also include a review of back office operations, including a review of key staff roles and responsibilities, the background of operations staff, the adequacy of computer and telecommunications systems, and a review of compliance policies and procedures.

Smaller pension plans are not as active hedge fund investors

Available data indicate that pension plans have increasingly invested in hedge funds and have continued to invest in private equity to complement their traditional investments in stocks and bonds. Further, these data indicate that individual plans’ hedge fund or private equity investments typically comprise a small share of total plan assets. However, data are generally not available on the extent to which smaller pension plans have made such investments. Because such investments require a degree of fiduciary effort well beyond that required by more traditional investments, this can be a difficult challenge for plans, especially smaller plans. Smaller plans may not have the expertise or financial resources to be fully aware of these challenges, or have the ability to address them through negotiations, due diligence, and monitoring. In light of this, such investments may not be appropriate for some pension plans.

Conclusions

The importance of educating investors [pension plans] about the special challenges presented by hedge funds has been recognized by a number of organizations. For example, in 2006, the ERISA Advisory Council recommended that Labor publish guidance about the unique features of hedge funds and matters for consideration in their use by qualified plans. To date, EBSA [Employee Benefits Security Administration] has not acted on this recommendation. More recently, in April 2008, the Investors’ Committee formed by the President’s Working Group on Financial Markets published draft best practices for investors in hedge funds. This guidance will be applicable to a broad range of investors, such as public and private pension plans, endowments, foundations, and wealthy individuals. EBSA can further enhance the usefulness of this document by ensuring that the guidance is interpreted in

Available data indicate that pension plans have increasingly invested in hedge funds and have continued to invest in private equity to complement their traditional investments in stocks and bonds. Further, these data indicate that individual plans’ hedge fund or private equity investments typically comprise a small share of total plan assets. However, data are generally not available on the extent to which smaller pension plans have made such investments. Because such investments require a degree of fiduciary effort well beyond that required by more traditional investments, this can be a difficult challenge for plans, especially smaller plans. Smaller plans may not have the expertise or financial resources to be fully aware of these challenges, or have the ability to address them through negotiations, due diligence, and monitoring. In light of this, such investments may not be appropriate for some pension plans.

GAO Recommendation

To ensure that all plan fiduciaries can better assess their ability to invest in hedge funds and private equity, and to ensure that those that choose to make such investments are better prepared to meet these challenges, we recommend that the Secretary of Labor provide guidance specifically designed for qualified plans under ERISA. This guidance should include such things as (1) an outline of the unique challenges of investing in hedge funds and private equity; (2) a description of steps that plans should take to address these challenges and help meet ERISA requirements; and (3) an explanation of the implications of these challenges and steps for smaller plans. In doing so, the Secretary may be able to draw extensively from existing sources, such as the finalized best practices document that will be published in 2008 by the Investors’ Committee formed by the President’s Working Group on Financial Markets.

DOL Response to GAO Recommendation

With regard to our recommendation, Labor stated that providing more specific guidance on investments in hedge funds and private equity may present challenges. Specifically, Labor noted that given the lack of uniformity among hedge funds, private equity funds, and their underlying investments, it may prove difficult to develop comprehensive and useful guidance for plan fiduciaries. Nonetheless, Labor agreed to consider the feasibility of developing such guidance.

GAO’s Response to the DOL’s Response

Indeed, the lack of uniformity among hedge funds and private equity funds is itself an important issue to convey to fiduciaries, and highlights the need for an extensive due diligence process preceding any investment.

SEC Charges Investment Adviser with Cherry-Picking

Leave a reply

So many of the investment advisory rules and regulations are based on common sense principles.  The story below is another example of a manager not using common sense with regard to the allocation of trades between different accounts.  Using a hedge fund’s assets to pay personal expenses is blatantly illegal.  Unfortunately there are too many of these cases out there and investors must do everything they can to protect themselves from such hedge fund frauds.  (One way to do this is through a hedge fund manager background check which is part of the hedge fund due diligence process.)

The article below can be found here.

SEC Charges Investment Adviser with Cherry-Picking

On September 9, the Commission charged James C. Dawson with securities fraud and investment adviser fraud, for orchestrating a cherry-picking scheme in which he allocated profitable trades to his personal account at the expense of his clients. Dawson is the investment adviser to a hedge fund, Victoria Investors, and individual clients.

The Commission’s complaint, filed in the U.S. District Court for the Southern District of New York, alleges that from April 2003 through October 2005, Dawson allocated profitable trades to his personal account by purchasing securities throughout the day in a single account and allocating the trades amongst his clients and his personal account after he saw whether the trades were profitable. The Commission’s complaint further alleges that Dawson used Victoria Investors’ funds to pay for personal and family expenses. Dawson did not tell his clients -Victoria Investors or his individual clients – about his cherry-picking scheme, and did not tell Victoria Investors that he was using fund assets for his personal expenses.

The Commission alleges that Dawson violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Investment Advisers Act. The Commission seeks an order permanently enjoining Dawson from violating these provisions of the federal securities laws, and seeks disgorgement of ill-gotten gains and losses avoided, plus prejudgment interest, and civil penalties against Dawson. [SEC v. James C. Dawson, 08 Civ. 7841 (SDNY) (WCC)] (LR-20707)

Hedge fund institutional investor due diligence

18 Replies

The goal of many hedge funds is to reach a point where they can start attracting investments from institutional investors. Many hedge funds (especially those with pedigreed managers) are able to start with backing from institutional investors while others (including many start up hedge funds) will need to develop a track record before seriously courting these types of investors. This article describes institutional investors and details some of the hedge fund due diligence procedures which institutional investors will put a fund through prior to investing.

What is an institutional investor?

Institutional hedge fund investors include state and corporate retirement and pension plans, endowments (non-profit and educational), banks, insurance companies and other types of corporations and companies. Sometimes there are very large hedge funds which will themselves invest in small and start up hedge funds – in such instances the large hedge fund will be acting as an institutional investor and will require many of the same due diligence materials. Institutional investors are important for the hedge fund community because they provide a very large potential base for investments.

What is hedge fund due diligence?

Hedge fund due diligence is the process that an investor goes through in order to vet a potnetial investment in a hedge fund. Due diligence will include the following:

  • background checks on all of the managers and employees of the management company
  • thorough review of all of the hedge fund offering documents
  • review of the management company’s risk management procedures

Due diligence document request

The timeline for an investment by an institutional investor is likely to be much longer than the time an individual investor will take to invest in your fund. Typically an investment will need to be approved by the managing director in charge of investments or alternatives; then the institutional investor’s compliance department will typically make a request for certain documents and/or other information. A sample list of the documents requested might look like the following:

Please provide the following information:

  1. Brokerage Agreement with [name of hedge fund broker]
  2. Copies of the executed partnership agreement(s)
  3. Copy of executed opinion of legal counsel relating to the legality of the interests [HFLB note: this is not a legal requirement and many funds do not receive an opinion of counsel with regard to these matters]
  4. Copy of executed opinion of legal counsel with respect to U.S. Federal Income Tax Consequences [HFLB note: this is not a legal requirement and many funds do not receive an opinion of counsel with regard to these matters]
  5. Any other legal opinions rendered in connection with the Partnership
  6. Reference name, title and telephone number for each auditor, legal counsel, clearing broker, custodian, consultant, administrator engaged by the Partnership of General Partner for the past two years
  7. A description of valuation policies and procedures [HFLB note: this may not be applicable to a fund; will depend on the investment strategy and the potential investments]

Depending on the nature of the institutional investor, you will see different levels of analysis of the actual trading style and returns of the fund. A sample reqest for information might include the following:

A detailed information on the trading program including:

  • list of investments
  • execution
  • frequency
  • diversification
  • liquidity

A detailed examination of historical returns including:

  • weekly/monthly/annual returns (best/worst/average)
  • sharpe ratio
  • sortino ratio
  • standard deviation
  • VaR
  • drawdown analysis

While I have hit upon most of the high points, any one institutional investor may have requests which are completely different from the items requested above. If you have any questions on the due diligence process or an investment into your fund from institutional investors, please don’t hesitate to contact me directly.

Hedge fund author fined $100k by the SEC for fraudulent hedge fund

Leave a reply

Summary:

Mark J.P. Boucher, the author of the book The Hedge Fund Edge, was involved in a hedge fund scam where he lured investors into a real-estate hedge fund which was was supposed to be secured by real property. The fund was not and investors lost millions of dollars. This underscores the necessity for hedge fund investors to protect themselves from these fraudsters by completing proper hedge fund due diligence. Please contact us if you have questions on hedge fund due diligence.

SEC Release:

Litigation Release No. 20689 / August 27, 2008
Securities and Exchange Commission v. Mark Joseph Peterson Boucher and Gary Paul Johnson,, Case No. CV 08-4088 (N.D. Cal. filed August 27, 2008); Securities and Exchange Commission v. John E. Brake,, Case No. CV 08-4089 (N.D. Cal. filed August 27, 2008)

SEC Charges Bay Area Investment Adviser, Others in Real Estate Investment Scam

The Securities and Exchange Commission today charged a Portola Valley investment adviser and newsletter publisher, Mark J.P. Boucher, with misleading clients into investing in two failed real estate development companies.

According to the Commission, Boucher helped raise around $20 million for the companies by falsely representing that the investments were secured by real estate, when in reality one of the companies owned no property, and the other owned a single property that was wholly underwater in debt. The Commission also sued the owners of each company, John E. Brake and Gary P. Johnson (both of Southern California) for misappropriating millions of dollars of investor funds to finance everything from beachfront homes to undisclosed side businesses. Boucher and Johnson have settled with the Commission without admitting or denying the allegations.

According to complaints filed today in federal district court in San Francisco, from 1999 through 2005, the defendants collectively raised about $20 million from investors based upon misrepresentations that the money would be used to fund large-scale real estate development projects and that the investments were secured by real property. In reality, the investments were not secured: one development company never owned property, and by the summer of 2002, the other company’s lone property was so heavily debt laden that its debts exceeded potential profits. In the end, neither company successfully developed a real estate project, and investors lost millions of dollars.

The Commission alleges that many investors became interested because Boucher — a hedge fund manager and the author of the book The Hedge Fund Edge — recommended the investments in a monthly newsletter he circulated to his advisory clients.

The Commission’s complaints allege that the defendants misused investor funds to pay for a wide variety of personal expenses. Among other things, Brake allegedly used investor funds to pay for a beachfront home rental in Carmel, California, luxury automobiles, a personal chauffeur, private jet travel, jewelry and designer clothing, while Johnson used investor funds to launch a failed furniture business. The Commission also alleges that Boucher used investor money to pay a portion of the mortgage on his personal residence.

Boucher, without admitting or denying the allegations in the Commission’s complaint, has agreed to a permanent injunction from further violations of Sections 17(a) and 17(b) of the Securities Act of 1933 (“Securities Act”), Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder (“Exchange Act”), and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940. Boucher will also pay a $100,000 civil penalty. In addition, Boucher has consented to the institution of public administrative proceedings against him in which he will be barred from serving as an investment adviser with a right to reapply after five years.

Johnson, without admitting or denying the allegations, has likewise agreed to a permanent injunction from further violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Johnson has also consented to an order requiring him to disgorge more than $1.8 million in ill-gotten gains and approximately $700,000 in prejudgment interest, and to pay a civil penalty of $120,000.

Brake is charged with violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The Commission is seeking injunctive relief, disgorgement, and civil money penalties against Brake.