SEC Charges Investment Adviser and Three Portfolio Managers in Connection with Multibillion Dollar Securities Fraud

On May 17, 2022, the SEC charged an investment adviser (Adviser) and three former senior portfolio managers in connection with a scheme, conducted over several years, to mislead investors about the significant downside risks of a complex options trading strategy (Strategy) used in seventeen unregistered private funds (Funds), in violation of antifraud and other provisions of the federal securities laws. As part of its settlement, the Adviser admitted that its conduct violated the federal securities laws and agreed, among other things, to the payment of over $1 billion to resolve the SEC charges. Two of the portfolio managers also agreed to the entry of partial judgments against them in which they consented to injunctive relief with monetary relief to be determined in the future. The Adviser and two of the portfolio managers also plead guilty to criminal charges in a parallel criminal proceeding. As a consequence of the guilty plea, the Adviser is automatically and immediately disqualified from providing advisory services to U.S. registered investment funds. In recognition of the seriousness of the allegations, in June 2020, the Adviser transferred management of its registered funds to another adviser and, simultaneously with the announcement of SEC charges, the Adviser announced the sale of its remaining U.S. asset management business.

The SEC order describing the settlement reveals that the Adviser misrepresented the level of protection provided by the Strategy’s hedging positions in marketing materials. The hedging positions that were actually implemented did not comply with the Strategy’s presentation materials and provided less protection during a short-term market crash than investors were led to believe and, due in part to this, the Funds “suffered catastrophic losses” during COVID-related market volatility in March 2020, “including losses in excess of 90% in certain funds.” The portfolio managers also failed to consistently implement a risk mitigation program related to the Funds’ use of “alpha” targets to generate additional profits. This risk mitigation program had specific parameters designed to address the largest client’s risk concerns and deter the client from withdrawing funds from the Strategy. Furthermore, the portfolio managers manipulated information provided internally and to investors, such as risk reports, daily performance data, and expected value sheets to conceal the level of downside risk and actual performance of the Strategy. In addition, the Adviser’s marketing materials misrepresented a capacity limit of $9 billion for certain funds (established to mitigate losses) when, at times, the Adviser exceeded that amount by over $3 billion.

As a result of these actions, investors lost over $5 billion at the time of the COVID-induced market crash, while the defendants had earned over $550 million in fees by the end of 2019. Among these investors were pension funds for teachers, clergy, bus drivers, and engineers. In addition, as the Funds lost billions, the portfolio managers are alleged to have engaged in numerous attempts to conceal misconduct from SEC staff, including the provision of false testimony.

S&K Note

In light of the extraordinary circumstances and outcome relating to this proceeding, S&K intends to publish additional content on this matter. Stay tuned to this blog to learn more.

The SEC press release can be found here.

The SEC order can be found here.