When the SEC promised to step up its scrutiny of hedge funds last year, it was not bluffing.
It has brought a wide range of cases against managers in the past few months alone. The latest case involves alleged fraud in valuing “side pockets” and other charges.
The regulator last Tuesday 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.”
The SEC alleges that the individuals also stole investor money to pay for their own personal investments and made material misrepresentations in connection with a private securities transaction.
“Side pockets” became very popular in the wake of the stock market’s blow-up in 2008 when many hedge fund managers had trouble meeting a raft of redemptions since, in some cases, a large chunk of their assets were stuck in illiquid investments. And valuing those illiquid investments has sometimes become dicey.
The SEC’s Asset Management Unit has been investigating whether funds have overvalued assets in side pockets while charging investors higher fees based on those inflated values.
In the Palisades case, the regulator alleges that in 2005 Mannion, Jr. and Reckles placed the Palisades hedge fund’s investments in World Health Alternatives — a now defunct medical staffing company — in a side pocket and valued those investments in “a manner that was inconsistent with fund policy and contrary to an undisclosed internal assessment.”
At the time, shares of World Health had fallen 93 percent after the company ran into financial difficulty and its chief financial officer resigned.
The SEC noted in its complaint that under the firm’s disclosed valuation policy, the fund’s World Health restricted stock should have been valued at $0. However, Mannion and Reckles valued the stock position at about $1.9 million in August 2005.
“Side pockets are not supposed to be a dumping ground for hedge fund managers to conceal overvalued assets,” said Robert B. Kaplan, Co-Chief of the SEC’s Asset Management Unit, in a statement.
The SEC also accused the pair of stealing more than $1.6 million worth of warrants belonging to the fund. It added that they took an undisclosed $2 million from the fund as an apparent short-term loan to finance their personal investments, and they deceived a securities issuer by making false representations about their trading positions in order to participate in a private offering by the issuer.
