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SEC Continues ‘Stepped-Up’ Investigation Into Rogue Hedge Funds

The SEC has, since October, brought at least five cases against hedge funds, which is part of a its plan to "step up its efforts in the hedge fund space."

The hedge fund space,” acknowledges Robert B. Kaplan, who along with Bruce Karpati are co-chiefs of the SEC’s Asset Management specialized unit, which is charged with focusing on investigations involving hedge funds, private equity funds, mutual funds investment advisors and investment companies.

Kaplan stresses that the SEC established a hedge fund working group in 2007 to take a more focused look at hedge funds and their strategies.

However, it clearly seems to have become much more of a priority since Mary Schapiro was appointed chairman of the SEC by President Obama. She in turn brought in former prosecutors such as Robert Khuzami to head up enforcement and George Canellos to run the New York office, which oversees most money managers. Both of them have publicly stated that they are interested in looking closer at some of the activities of hedge funds.

Some of the cases involve illegal insider trading, others accuse the managers of misappropriating clients money while other cases involve outright theft.

But underlying most of these cases are disclosure issues, Kaplan concedes. The SEC’s thinking is that while private funds like hedge funds and PE funds are less regulated than mutual funds, they still have a fiduciary responsibility to their clients. “So much of the relationship between the fund and its investors is driven by fund representations in documents -- including the private placement,” said Kaplan.

So, the SEC spends a lot of its time looking at valuation of illiquid securities, as well as conflicts of interest or disparate treatment of clients — issues that came to the fore when hedge funds gated clients after the market’s 2008 implosion.

For example, last month the SEC charged hedge fund manager Stephen M. Hicks and his investment advisory businesses with defrauding investors in funds managed by Southridge Capital Management LLC and Southridge

Advisors LLC, by overvaluing the largest position held by the funds. He was also accused of misusing investor money to pay the legal and administrative expenses of other funds managed by Hicks and Southridge.

Last month, the SEC charged two hedge fund portfolio managers — Paul T. Mannion, Jr. and Andrews S. Reckles — and their investment advisory businesses, PEF Advisors Ltd., and PEF Advisors LLC, with defrauding investors in the Palisades Master Fund, L.P. by overvaluing illiquid fund assets they placed in a “side pocket.”

Going forward, the SEC is looking at potential problems with investment advisors and what it calls “suspicious fund performance.”

It is working closely with the SEC’s examination staff to get a better handle on the kinds of misconduct that might take place.

Hedge funds should once again consider themselves warne

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