Among recent actions taken by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) were charges against a former hedge fund advisory firm and two of its executives for fraud and numerous actions on reporting failures, unsuitable investments and supervisory failures.
Former billion-dollar hedge fund advisory firm, execs charged
The SEC charged a former $1 billion hedge fund advisory firm and two executives with scheming to overvalue assets under management and exaggerate the reported returns of hedge funds they managed so that they could hide losses and increase investor fees.
The case, the seventh to do so, arose from the SEC’s Aberrational Performance Inquiry, an initiative by the Enforcement Division’s Asset Management Unit that uses proprietary risk analytics to identify hedge funds with suspicious returns. Performance flagged as inconsistent with a fund’s investment strategy or other benchmarks forms a basis for further investigation and scrutiny, the SEC says.
The SEC alleged that New Jersey-based Yorkville Advisors LLC, its founder and president Mark Angelo, and chief financial officer Edward Schinik lured pension funds and other investors to invest in their hedge funds by falsely portraying Yorkville as a firm that managed a highly collateralized investment portfolio and employed a robust valuation procedure. They misrepresented the safety and liquidity of the funds’ investments, and charged excessive fees to the funds based on the investments’ fraudulently inflated values.
According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, Yorkville, Angelo, and Schinik defrauded investors in the YA Global Investments (U.S.) LP and YA Offshore Global Investments Ltd hedge funds.
The SEC alleges that Yorkville and the two executives failed to adhere to Yorkville’s stated valuation policies and ignored negative information about certain investments by the funds. In addition, they kept the adverse information about the investments from Yorkville’s auditor, so that the firm could continue to carry some of its largest investments at inflated values. They also misled investors about the funds’ liquidity, underlying collateral, and Yorkville’s use of a third-party valuation firm.
The SEC alleges that by fraudulently making Yorkville’s funds more attractive to potential investors, Angelo and Schinik enticed more than $280 million in investments from pension funds and funds of funds. This enabled Yorkville to charge the funds at least $10 million in excess fees based on the inflated values of Yorkville’s assets under management.
FINRA Sanctions Citigroup Global Markets on Reporting, Other Failures
Citigroup Global Markets was censured, fined $900,000, and required to pay $32,355.82, plus interest, in restitution to customers on FINRA findings that it failed to report the correct contra-party’s identifier for transactions in TRACE-eligible securities to FINRA’s Trade Reporting and Compliance Engine (TRACE). The firm neither admitted nor denied the findings in consenting to the sanctions, and FINRA considered, among other things, the remedial efforts the firm had taken to enhance its supervisory procedures and systems.
FINRA found that the firm failed to report transactions in TRACE-eligible securities to TRACE within 15 minutes of the execution time, failed to report the correct trade execution time for transactions in TRACE-eligible securities to TRACE, failed to show the correct execution time on the memoranda of brokerage orders, and reported transactions in TRACE-eligible securities that it was not required to report.
Findings also included numerous other reporting failures, as well as a determination that in transactions for or with a customer, the firm failed to use reasonable diligence to ascertain the best interdealer market and failed to buy or sell in such market so that the resultant price to its customer was as favorable as possible under prevailing market conditions. Moreover, FINRA found that in some transactions, the firm sold (or bought) corporate bonds to (or from) customers and failed to sell (or buy) such bonds at a price that was fair, taking into consideration all relevant circumstances, including market conditions with respect to each bond at the time of the transaction, the expense involved and that the firm was entitled to a profit. Merrill Lynch Fined $450,000 on Supervisory Control System Failures
Merrill Lynch, Pierce, Fenner & Smith Incorporated was censured and fined $450,000 by FINRA over supervisory control system failures. Without admitting or denying the findings, the firm consented to the entry of findings that its supervisory control system failed to include a policy or procedure requiring a review to detect or prevent multiple transmittals of funds from multiple customers going to the same third-party accounts.
The findings stated that the firm’s system failed to include exception reports that would have identified multiple customer wires going to the same third-party account. Consequently, the firm failed to detect that a registered representative had initiated fund transfers totaling approximately $887,931 out of customer accounts to bank accounts he apparently controlled. The registered representative has been barred from association with any FINRA member in any capacity and the firm has repaid each of the affected customers.