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Lipper Manager Charged with Fraud by SEC, U.S. Att

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CHICAGO (–Former Lipper & Co. LP manager Edward J. Strafaci was hit with a double whammy of civil charges of fraud from the U.S. Securities and Exchange Commission and a criminal indictment from the U.S. Attorney of the Southern District of New York.

The SEC alleges that Mr. Strafaci overstated the value of securities owned by Lipper convertible hedge funds, leading to incorrect hedge fund values, inaccurate statements and the filing of false reports to the SEC, which is based in Washington.

The U.S. Attorney’s charges relate to securities fraud and investment advisory fraud that culminated in the overstatement of the value of hedge funds managed by Mr. Strafaci to the tune of hundreds of millions of dollars.

Mr. Strafaci–who now heads the firm he co-founded, Stratos Capital Management Corp., New York–was unavailable for comment. A statement from his attorney, Seth L. Rosenberg, said the case is unusually complex and should have been resolved outside the criminal justice system. The indictment ignores the difficult issues in pricing securities “for which there is no marketplace of record,” Mr. Rosenberg stated. “Edward Strafaci has always acted with the highest degree of professionalism and integrity while serving the best interests of investors. We are confident that he will be fully exonerated,” he said in the statement.

News of problems with the Lipper funds first hit in February 2002, resulting in two restatements of performance for the previous year. The funds were liquidated with investors getting some of their money back earlier this year . Late last year, founder Ken Lipper got out of the hedge fund business completely Previous HedgeWorld Story. Class-action lawsuits also have been filed on behalf of Lipper investors .

The SEC suit concerns Mr. Strafaci’s management of four hedge funds: Lipper Convertibles LP; Lipper Convertibles Series II LP; Lipper Offshore Convertibles LP; and Lipper Fixed Income LP. The SEC notes that relatively small overstatements of securities values in the fund, in the range of 12% to 19%, resulted in fund value overstatements of as much as 49%. The leverage in the fund had a big effect on the mispricing, said Wayne M. Carlin, director of the SEC’s Northeast Regional Office.

The U.S. Attorney’s office targeted Mr. Strafaci over alleged overpricing of securities that led to higher profits for the fund and himself. In March of 2002, Lipper announced significant losses on its convertible hedge funds, even though previous statements had indicated there were gains. Lipper estimated then that it had to write down Lipper Convertibles LP by 45% from its original 2001 statement. The restatement for the offshore fund, Lipper Offshore Convertibles, appeared to be 10% lower for 2001.

Unsurprisingly, final liquidation values were not pretty. The U.S. Attorney’s office said in its indictment that the Lipper Convertible Fund, which had reported approximately US$722 million in partnership capital before Mr. Strafaci resigned, reported approximately US$365 million in partnership capital upon liquidation. The Lipper Convertible Fund Series II, which had reported approximately US$29.5 million in partnership capital before Mr. Strafaci’s resignation, reported approximately US$21.1 million in partnership capital upon liquidation, the indictment states.

The indictment accuses him of creating those increased values by ignoring the pricing methods identified in the fund offering memorandums and using his own prices instead.

And as the funds allegedly were being overvalued, Mr. Strafaci’s bonus compensation soared. His bonuses for the following years were: US$850,000 in 1998; US$1.05 million in 1999; US$1.15 million in 2000; and US$850,000 in 2001, all on top of his salary of US$150,000, according to the indictment. In addition to acting as fund manager, Mr. Strafaci also was Lipper’s chief compliance officer, according to the indictment.

The SEC’s investigation is not over. Mr. Strafaci has 20 days to respond to its civil action. The SEC seeks a permanent injunction, disgorgement of profits and civil money penalties.

He faces a maximum penalty of 30 years in prison for the U.S. Attorney’s criminal charges if convicted, as well as potential fines of up to US$1.25 million or twice the gross gain or loss resulting from the crimes, according to a statement from the U.S. Attorney. The SEC and the U.S. Attorney worked together on their investigations in cooperation with the Federal Bureau of Investigation.

Lipper & Co. executives cooperated with the investigation, while Mr. Strafaci did not, according to the U.S. Attorney’s indictment.

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