Tag Archives: hedge fund fraud

Another Ponzi Scheme

Broken Record

I’ve said it all before.  The following press release can be found here.  Please see the following articles on hedge fund and investment advisor fraud.

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Investment Advisor Fraud

Another Investment Advisor Ponzi Scheme

In the wake of the Madoff scandal the SEC is taking out other fraudulent investment advisory firms.  The release below details a south Florida investment advisor who perpetrated a multi-million dollar ponzi scheme.  As we noted in Lessons in Hedge Fund Due Diligence, it is so important for investors to conduct proper due diligence on their investment advisors or hedge fund managers. Continue reading

Another Commodity Pool Operator Fraud – Lesson in Hedge Fund Due Diligence

We frequently discuss scams involving the investment management and hedge fund industry as a warning to potential hedge fund investors to take the hedge fund due diligence process seriously.  In the CFTC release posted below, we have a classic scam where the sponsors of a commodity/futures fund acted in a fraudulent manner and used the assets of the fund for their own personal reasons.  We have listed the items which the consent order found and how an experienced hedge fund due diligence team could have protected the investor from fraud. Continue reading

Hedge Funds Blindsighted by Massive Ponzi Scheme

According to a SEC release this morning (and every other financial news agency), major hedge funds, banks and other financial institutional were caught in a Ponzi scheme of epic proportions.  While it is hard to believe that such large groups were blindsighted by this, it does showcase the fact that fraud can happen to even sophisticated investors and that hedge fund due diligence (an ongoing due diligence) is absolutely required.  The SEC release is reprinted below. Continue reading

Hedge Fund Fraud – Prominent Hedge Fund Attorney is Wrongdoer

Usually our discussion of hedge fund frauds revolves around unscrupulous promoters who engage in some sort of fraudulent behavior against hedge fund investors.  Most of the time the fraud is based on some sort of ponzi scheme.  However, in the case reprinted below, the fraud was actually perpetuated against many hedge funds, including some funds with a significant amount of assets under management.  Even more incredible is that the fraud was perpetuated by a hedge fund attorney with a very impressive background.  While this is slightly different than hedge fund affinity fraud, it does show that frauds can be found on all scales and that hedge fund due diligence is important for both investors and hedge funds.  It is important, maybe now more so than ever, that hedge funds conduct proper due diligence on their counterparties when engaging in private placements and off-exchange transactions.  Please contact us if you have any questions on hedge fund due diligence. Continue reading

Hedge Fund Due Diligence – Affinity Fraud Alert

In these uncertain and volatile markets hedge fund due diligence is more important than ever.  We’ve discussed how hedge fund due diligence is likely to change, but it is also important to note that hedge fund frauds can be detected through simple due diligence procedures.  In this vein, the NFA has released a notice and an alert on “affinity fraud.”  The NFA alert points out that there are many ways a potential hedge fund investor can protect themselves from a fraud by conducting basic research on the investment advisor, commodity pool operator, or forex manager.  If you are a hedge fund investor and would like a referral to a due diligence firm, please contact us.  Continue reading

Fraudulent Commodity Pool Operator Issued Injunction

A commodity pool operator is issued an injunction for fraudulent behavior.  In classic fashion, this fraudster touted performance results which were grossly inaccurate.  The scheme ended earlier this year and investors lost almost $6 million dollars.  As we’ve noted before, hedge fund investors (including those investors in commodity and futures hedge funds) need to make sure to complete due diligence on the hedge fund and hedge fund manager.  The release below details the events and injunction.  Continue reading

Hedge Fund Manager Fined and Banned for a Year for “Portfolio Pumping”

This is another example of a hedge fund manager acting with incredible audacity.

Last week the SEC issued a release detailing an action taken against a hedge fund manager for his “portfolio pumping” practices.  Bascially the manager was caught buying a large amount of shares through another fund he ran in order to boost the price of the thinly traded security.  The manager then charged higher management fees based on the inflated price of the securities.  The manager was fined $100,000 and ordered to disgorge the higher management fee of $80,000.

The end of the release states that the adviser will be allowed to reapply for association with an investment advisor for a year, but I believe the damage has been done.  If this manager does start another fund, proper hedge fund due diligence will show this SEC action which by itself should send investors running for the door.  In this case the hedge fund manager ruined his career for a few thousand dollars.

The release can be found in full here.

SEC Charges San Francisco Hedge Fund Adviser for “Portfolio Pumping”

Washington, D.C., Oct. 16, 2008 — The Securities and Exchange Commission today charged San Francisco investment adviser MedCap Management & Research LLC (MMR) and its principal Charles Frederick Toney, Jr. with reporting misleading results to hedge fund investors by engaging in a practice known as “portfolio pumping.”

The SEC alleges that Toney made extensive quarter-end purchases of a thinly-traded penny stock in which his fund was heavily invested, more than quadrupling the stock price and allowing him to report artificially inflated quarterly results to fund investors. Without admitting or denying the SEC’s allegations, MMR and Toney have agreed to settle the charges by paying financial penalties and agreeing to an order barring Toney from acting as an investment adviser for at least one year.

“Fund investors relied on MMR and Toney to abide by their fiduciary duties and put the fund’s interests ahead of their own,” said Marc J. Fagel, Regional Director of the SEC’s San Francisco Regional Office. “Instead, Toney engaged in trading activity which hid his poor performance.”

According to the SEC’s order, MedCap Partners L.P. (MedCap), a hedge fund run by MMR and Toney, was suffering from dramatic losses and facing increasing redemptions from fund investors by September 2006. Over the last four days of the month, Toney — through a separate fund that MMR managed — placed numerous buy orders for a thinly-traded over-the-counter stock in which MedCap already was heavily invested. Toney’s buying pressure caused the stock price to more than quadruple, from $0.85 to $3.72.

The SEC alleges that because the stock represented over one-third of MedCap’s holdings, the brief boost in its price inflated MedCap’s reported value by $29 million, masking what would otherwise have been a 40 percent quarterly loss for MedCap. Immediately after the quarter ended, Toney reported to MedCap’s investors that the fund’s investments had begun to “bounce” and that the fund’s performance was improving. Toney failed to disclose that this “bounce” was almost entirely the result of his four-day purchasing spree. Following MMR’s brief buying activity, both the stock price and MedCap’s asset value declined to their previous levels.

According to the SEC’s order, at the same time, MMR charged fees to the fund based on the inflated quarter-end asset value.

The Commission found that MMR and Toney breached their fiduciary duties to MedCap and to MMR’s other fund in which the penny stock was acquired. Toney and MMR, without admitting or denying the Commission’s findings, have agreed to cease and desist from violating the antifraud provisions of the Investment Advisers Act of 1940. MMR also will disgorge the higher management fees it received due to the inflated fund asset value, plus interest — an amount totaling $70,633.69 — and receive a Commission censure. Toney also has agreed to a bar from association with any investment adviser with the right to reapply after one year, and to pay a $100,000 penalty.

Other releated articles:

Please contact us if you have questions or if you would like to discuss.

SEC Wins another Hedge Fund Fraud Case – Provides Insight to Hedge Fund Managers

Hedge fund fraud cases are important because they give some definition and life to the various investment advisor and hedge fund laws.  Much of the advice that hedge fund lawyers give to their clients is based on reasonableness and best guesses on how the securities laws will be implemented in the hedge fund context.  For many hedge fund issues there are not clear cut cases which give color to the securities laws.  One of my colleagues refers to this as the “square peg – round hole” dilemma by which he means it is hard to apply the archaic securities laws with the current state of the hedge fund and investment management industry.

When the SEC does bring cases, as practitioners we get to see how the SEC views the securities rules and how we should be advising clients. While many of the fraud cases represent completely unbelievable actions by unscrupulous people, there are still lessons which well-intentioned managers can learn from.

Specifically this case gives us an opportunity to examine five separate areas which invesment managers should be aware of:

1.    Make sure all statements in the hedge fund offering documents and collateral marketing materials is are accurate.

In this case the hedge fund offering documents contained many material misstatements including materially false and misleading statements in offering materials and newsletters about, among other things, the Funds’ holdings, performances, values and management backgrounds.  For example the complaint alledges:

Specifically, both PPMs represented that most investments made by Partners and Offshore would trade on “listed exchanges.” In truth, a majority of those funds’ investments were and are on unlisted exchanges such as the OTCBB or pink sheets. Furthermore, the Partners’ PPM stated that investors would receive yearly audited financials upon request. Partners has not obtained audited financials since the year ended 2000 and repeatedly refused at least one investor’s requests for audited financials for the year ended 2001.

2.    Make sure all appropriate disclosure relating to personnel are made.

Hedge fund attorneys will usually spend time with the manager discussing the employees of the management company and their backgrounds.  During this time the attorney will ask the manager, among other questions, whether any person who is part of the management company has been involved in any securities related offense.  In this case there were two specific items which the manager should have disclosed in the offering documents and other collateral material:

Failed to disclose that a “consultant” to the management company was enjoined, fined and also barred from serving as an officer or director of a public company for five years for his fraudulent conduct involving, among other things, misallocating to himself securities while serving as CFO and later president of a publicly traded company.

Failed to discloase a member of the fund’s board of directors was barred from associating with any broker or dealer for 9 years.

3.    Take care when going outside stated valuation policies.

Many hedge fund documents have stated valuation policies but then allow the manager to modify the valuation, in the manager’s discretion, to better reflect the true value of the securities.  However, when a manager uses this discretion, the manager should have a basis for the valuation.  Such valuation should not be based on an artificially inflated value of the asset.  To be safe managers should probably have some internal valuation policies which should be in line with generally accepted valuation standards for such assets.  I found the following paragraph from the SEC’s complaint particularly interesting (emphasis added):

II. Bogus Valuations

34. In order to obtain at least year end 2001 audited financials for Offshore, Lancer Management provided Offshore’s auditor with appraisals valuing certain of that fund’s holdings. These appraisals mirrored or closely approximated the values assigned to Offshore’s holdings by Defendants based on the manipulated closing prices at month end. These valuation reports were, however, fatally flawed and did not reflect the true values of Offshore’s holdings under the generally accepted Uniform Standards of Professional Appraisal Practice or American Society of Appraisers Business Valuation Standards. For example, the valuations were improperly based on unreliable market prices of thinly traded securities; unjustified prices of private transactions in thinly traded securities; unfounded, baseless and unrealistic projections; hypotheticals; and/or an averaging of various factors. Indeed, under accepted standards of valuing businesses, certain of the Funds’ holdings were and/or are essentially worthless.

4.    Do not engage in market manipulation.

Many of the securities in which this hedge fund invested were traded on the OTCBB.  The fund engaged in trading in these securities near valuation periods in order to artificially inflate the price of these very thinly traded securities.  Additionally, the complaint alleges many incidents of “marking the close.”  This goes without saying but a hedge fund manager should not engage in market manipulation.

5.    Always produce accurate portfolio statements.  Do not overstate earnings.  Always make sure that statements to investors are accurate.

Enough said.

While many of the examples above are so egregious they probably do not need to be listed on a “do not” list, you should make sure you do not engage in any of these activities. Additionally, if you do make some error or mistake (for example, if a valuation turns out to be incorrect or inaccurate), immediately contact your attorney to create a plan to inform investors about the incorrect or inaccurate statements.  A mistake can generally be cured, all out fraud cannot.

I have posted a full text version of the SEC’s case, SEC v. Lauer.  I have included the statement by the SEC below which can be found here.


SEC Wins Major Hedge Fund Fraud Case Against Michael Lauer, Head of Lancer Management Group


Washington, D.C., Sept. 24, 2008—The Securities and Exchange Commission announced that a district court judge today granted its motion for summary judgment against the architect of a massive billion-dollar hedge fund fraud.

Michael Lauer of Greenwich, Conn., was found liable for violating the anti-fraud provisions of the federal securities laws. In a 67-page order, The Honorable Kenneth A. Marra, U.S. District Judge for the Southern District of Florida, found that Lauer’s fraud as head of two Connecticut-based companies – Lancer Management Group and Lancer Management Group II – that managed investors’ money and acted as hedge fund advisers was “egregious, pervasive, premeditated and resulted in the loss of hundreds of millions of dollars in investors’ funds.”

Linda Chatman Thomsen, Director of the SEC’s Division of Enforcement, said, “This case highlights the SEC’s ongoing efforts to combat hedge fund fraud and our dedicated work on behalf of investors to ensure that hedge fund managers are held accountable for any unlawful conduct.”
David Nelson, Director of the SEC’s Miami Regional Office, added, “We are particularly gratified at this decision, which resulted from several years of hard work to protect investors, starting when we successfully halted the fraud while it was still ongoing.”

Lauer raised more than $1.1 billion from investors and his fraudulent actions caused investor losses of approximately $500 million. The SEC initially won emergency temporary restraining orders and asset freezes against Lauer and his companies, which were placed under the control of a Court-appointed receiver after the SEC filed its enforcement action in 2003.

During the protracted litigation, the SEC successfully stopped Lauer from diverting or hiding millions of dollars of assets from the Court’s asset freeze.

The summary judgment order found that Lauer:

  • Materially overstated the hedge funds’ valuations for the years 1999 to 2002.
  • Manipulated the prices of seven securities that were a material portion of the funds’ portfolios from November 1999 through at least April 2003.
  • Failed to provide any basis to substantiate or explain the exorbitant valuations of the shell corporations that saturated the funds’ portfolios.
  • Hid or lied to investors about the Funds’ actual holdings by providing them with fake portfolio statements.
  • Falsely represented the funds’ holdings in newsletters.

The judge’s order entered a permanent injunction against Lauer against future violations of Sections 17(a)(1)-(3) of the Securities Act of 1933 (Securities Act), Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 (Exchange Act), and Sections 206(1) and (2) of the Investment Advisers Act of 1940 (Advisers Act). The order reserved ruling on the SEC’s claim for disgorgement with prejudgment interest against Lauer, and on the amount of a financial penalty Lauer must pay. The SEC is seeking a financial penalty and disgorgement of the more than $50 million Lauer received in ill-gotten gains from his fraudulent scheme.