Hedge funds are complex in nature and can take on a high level of risk. Paired with the large sums of money being handled and investors’ net worth, hedge funds become prime breeding grounds for fraud.
While this is not to say that all hedge funds are fraudulent, there is, unfortunately, a high rate of fraud in this industry given the amount of money handled. When fraud does occur, it is most commonly seen as an intentional compliance failure or an abuse of power/position.
Let’s take a closer look at the types of common fraud that takes place in hedge funds, as well as some recent examples.
There are several regulations in place regarding how advisers present risk parameters to investors in order to fully disclose any possibilities of significant losses. Fund managers must show transparency and honesty when discussing their risk management procedures.
Case in Point: Catalyst Capital Advisors LLC/Jerry Szilagyi
In January 2020, The Securities and Exchange Commission (SEC) announced charges against Catalyst Capital Advisors LLC (CCA) and President and Chief Executive Officer Jerry Szilagyi. They agreed to pay a combined $10.5 million in settlement fees for breaching risk parameters and failing to take corrective action in response. While investors were told the risk management process had safeguards to prevent losses of more than 8%, the fund lost approximately 20% of its value from December 2016 to February 2017, and no corrective action was taken.
Compliance failures related to policies and procedures
Private funds are also subject to compliance regulations around properly showing the value of securities in funds. When fund managers fail to comply, they can undervalue securities and sell them for a profit when they want. To combat this, fund managers are required to prove information about valuation and pricing vendors.
Case in Point: Deer Park Road Management Company, LP
In June 2019, The SEC announced that Deer Park Road Management Company, LP agreed to pay $5 million in settlements, with their Chief Investment Officer paying an additional $250,000 penalty. The case against them included failures to have policies and procedures that addressed risk along with providing inaccurate information to a pricing vendor. That allowed them to mark assets up gradually rather than marking them to market as required.
Abuse of power or position
Many hedge fund managers hold positions on committees and boards, making them influential within the industry. Sometimes that influence goes too far, and individuals abuse their power and position for their own benefit. Not only is this immoral, but it is also illegal when it interferes with objective decision-making.
Case in Point: Daniel Kamensky
In September 2020, the SEC charged Daniel Kamensky with abusing his position as co-chair of the unsecured creditors committee in the Neiman Marcus Group Ltd. LLC Chapter 11 bankruptcy proceedings. He leveraged his position on the committee to manipulate a bidding process in order to benefit a portfolio he managed at the expense of the unsecured creditors. The complaint described that he sought to purchase securities being distributed as part of the Neiman Marcus proceedings and coerced a competing bidder to withdraw their higher bid using his committee position.
What to do if you suspect hedge fund fraud
If you believe you’ve witnessed hedge fund fraud, you can be part of the solution. While it may be an unsettling or downright scary process, it’s the right thing to do — becoming a whistleblower in these instances can hold individuals accountable for their actions and prevent people from losing a significant amount of money in the future.
Whistleblowing is a lot less stressful when you have the right team by your side — having experienced law professionals, past whistleblowers, and investigators advocating for you increases the chance of a positive outcome.
As a whistleblower, you are valued and appreciated by the team at the Daniel J. Ocasio Whistleblower Law Group. Reach out today to schedule a confidential consultation about the hedge fund fraud you have witnessed.