A hedge fund employee was paid $10,000 a month in soft dollars reported falsely as research fees, the SEC said.

The Securities and Exchange Commission on Monday charged a Minneapolis-based hedge fund manager, his investment advisory firm and an accomplice with bilking investors in two hedge funds out of more than $1 million using fake research expenses and fees.

The SEC alleges that as the management fees earned by Archer Advisors LLC were shrinking due to the funds’ worsening performance, the firm’s owner, Steven R. Markusen, and an employee, Jay C. Cope, implemented a scheme to enrich themselves at the expense of investors in the funds, including diverting soft dollars to pay Cope’s salary.

Markusen routinely caused the funds to reimburse Archer for fake research expenses, and he eventually routed much of that money to his personal checking account and spent it on country club dues, boarding school tuition and a Lexus, among other luxury items, the SEC says.

Markusen also devised a way to essentially charge fund investors twice for the same fake research expenses.

Says the SEC: First, he billed the funds directly by falsely claiming that Archer had paid Cope to conduct “research” for the funds. Second, he and Cope improperly diverted soft dollars from the hedge funds to Cope for the same purported “research” under the additional pretense that Cope was an independent consultant.

“Soft dollars were supposed to be used to buy third-party investment research that benefited the funds,” the SEC says. “Cope conducted no third-party research as an Archer officer whose main duties were placing trades and helping Markusen find new investors.” 

The SEC’s complaint, filed in federal court in Minneapolis, also charges Markusen and Cope with conducting a separate scheme to manipulate the stock price of the funds’ largest holding in order to inflate the monthly returns reported to investors and conceal the true extent of the funds’ mounting investment losses.

“Markusen and his firm had an obligation to manage investor money in the hedge funds fairly and honestly,” said Robert J. Burson, associate director of the SEC’s Chicago Regional Office. “Instead, he and Cope exploited their control of the funds to engage in long-running schemes to misappropriate fund assets and artificially pump up the value of the poorly performing funds.”

According to the SEC’s complaint, the scheme enabled Markusen to secretly pay Cope’s salary with fund soft dollars rather than out of Archer’s coffers.

“Markusen and Cope disguised Cope’s $10,000 monthly salary payments as research fees because under the governing documents of the hedge funds they managed and SEC rules, Archer employees could not draw a salary from fund assets or receive fund soft dollars for non-research assistance,” the complaint says.

The SEC alleges that Markusen and Cope traded excessively in the funds’ brokerage accounts in order to generate enough soft dollars to pay Cope’s monthly salary at Archer.

“They misrepresented Cope’s relationship with Archer to the brokerage firms that administered the funds’ soft dollars, and created false and misleading monthly ‘research’ invoices for the amount of Cope’s salary.”

Markusen and Cope sent the invoices each month to the funds’ brokerage firms, who in turn paid fund soft dollars directly to Cope for the purported research expenses. Markusen would then receive a $1,000 monthly kickback from Cope, the SEC said.

According to the SEC’s complaint, Markusen and Cope carried out their portfolio pumping scheme by manipulating the price of the thinly traded stock of CyberOptics Corp. (CYBE), which made up more than 75% of the funds’ portfolios and was by far the largest holding. “Knowing that Archer’s trading as CYBE’s largest shareholder could materially impact the market price,” the SEC said, “Markusen and Cope ‘marked the close’ in CYBE on the last trading day of the month at least 28 times.”

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