Adviser Charged with Portfolio Pumping
12.28.2005 The SEC brought charges against Schultz
Investment Advisors, Inc. and Scott Schultz, finding that,
from at least June 2002 through December 2003, Scott Schultz,
President and founder of Schultz Investment, fraudulently engaged in
marking-the-close transactions by regularly placing large, end-of-the-
quarter trades in four thinly-traded closed-end funds within five
minutes of market close. Schultz placed these trades in an attempt to boost the closing prices
of the funds. As a result, he was able to report better quarterly performance
results for his clients' portfolios. Schultz Investment benefited by
collecting more management fees from its clients. Schultz Investment
also misrepresented the investment strategies of its portfolios that
it offered to clients and, as a beneficial owner of more than 5% of
two closed-end funds, failed to file the required Schedule 13G with
the Commission.
Please click http://www.sec.gov/litigation/admin/33-8650.pdf for a copy of the administrative action.
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Hedge Fund Portfolio Managers Charged with Market Timing
12.22.2005 The SEC filed civil fraud charges against two
former San Francisco hedge fund managers, Brent W. Federighi and Michael C. Hoffman, in connection with
their conduct between 2000 and 2002 on behalf of the Ilytat hedge
fund, which they co-managed and which closed in August 2002, and in
connection with Federighi's conduct from September 2002 to October
2003 in managing the Gage Capital hedge fund after Ilytat closed. In
May 2001, Ilytat's domestic and offshore funds had a total of
approximately $130 million in assets, and when Gage closed in 2003 it
had approximately $55 million in assets in its domestic and offshore
funds.
According to the SEC's complaint, Federighi and Hoffman
deliberately exploited a loophole in their broker's mutual fund order
entry system to place over 3,000 fraudulent late trades (representing
over 80% of their hedge funds' mutual fund trades) in over 400
different mutual funds, allowing them to obtain better prices for
their mutual fund shares than other investors received. The late
trading by Federighi and Hoffman caused losses of approximately $49
million to other mutual fund investors through the hedge funds'
improper receipt of stale fund prices. Some trades were placed as late
as 5:45 p.m. (Eastern Time), or 1.75 hours after the time as of which
the mutual funds' prices were set.
In addition, Federighi and Hoffman allegedly engaged in short-term
trading in mutual funds, in violation of the mutual funds' rules. When
the mutual funds discovered this improper market timing, they
restricted or barred Ilytat and Gage from investing in the funds.
Federighi and Hoffman then allegedly used deceptive techniques to
conceal the hedge funds' identities in order to continue market timing
those funds. Among other things, Ilytat and Gage placed trades using
multiple, non-consecutively numbered accounts to conceal their
identities from the funds.
Please click http://www.sec.gov/litigation/litreleases/lr19510.htm for a copy of the administrative action.
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Hedge Fund Advisers Charged with Fraud
12.21.2005 The SEC filed an emergency enforcement action against Robert M. Massimi and Bret A. Grebow through a hedge fund, HMC International, LLC to prevent ongoing fraud. The SEC alleges that from late 2001 to the present, Massimi, the
Fund's manager, and Grebow, the Fund's trader, raised approximately
$12.9 million from approximately 80 investors through a fraudulent
offering of investments in HMC, and that Massimi and Grebow
misappropriated more than $5.2 million of these investor funds for
their own use.
The SEC also alleges that Massimi and Grebow
materially misrepresented the Fund as a pooled investment vehicle that
engaged in "low risk" day trading. Furthermore, Massimi and Grebow
sent investors false monthly account statements that portrayed their
investments as profitable when, in reality, Grebow was systematically
looting the Fund's trading account and Massimi was continually
benefiting from lucrative "profit" distributions and unauthorized
expenses that he paid to himself and Grebow from new investor funds.
Massimi also falsely assured investors that he was a hands-on manager,
who maintained diligent oversight of the Fund's assets and trading.
The Commission further alleges that, recently, as Massimi faced
increasing investor concerns about the Fund's legitimacy and
government inquiries into his misconduct, Massimi diverted assets to
others, including the Relief Defendant, to shield them from investors
and government authorities.
Please click http://www.sec.gov/litigation/litreleases/lr19508.htm for a copy of the administrative action.
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Investment Adviser Representatives Charged with Illegal Market Timing
12.16.2005 The SEC broght charges against Martin J. Druffner, who was an employee from approximately April 1996
until at least June 2003, of Prudential
Securities, Inc., then a registered broker-dealer and investment
adviser. The SEC alleges that, from at least 1999 through in
or about October 2003, Druffner defrauded mutual funds by employing
various deceptive and fraudulent acts and practices to execute
prohibited market timing trades on behalf of seven hedge fund
customers. Druffner's deceptive and
fraudulent conduct consisted of three basic categories of conduct:
- creating and using multiple customer account numbers;
- creating and
using multiple financial advisor, or FA numbers; and
- making affirmative representations and material omissions to employees at
mutual fund companies about the true nature and extent of his market
timing, all for the purpose of avoiding detection by mutual funds.
Among other things, Druffner engaged in this
conduct after he was notified, explicitly and repeatedly, both that
mutual fund companies prohibited his customers' market timing
activity, and, in some cases, that mutual fund companies had precluded
Druffner from further trading because of repeated violations of their
prospectus limitations. According to the Information, Druffner
generated in excess of $2,000,000 in net commissions as a result of
his deceptive and fraudulent scheme.
Please click http://www.sec.gov/litigation/litreleases/lr19496.htm for a copy of the administrative order.
Similar cases were brought against two other former Prudential registered representatives.
Please click http://www.sec.gov/litigation/admin/34-52964.pdf and http://www.sec.gov/litigation/admin/34-52962.pdf for copies of the administrative orders.
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Adviser Charged with Improper Placement of IPO of an Affiliate with Client
12.16.2005 The SEC charged Nathan Chapman, an investment adviser, with the improper placement of an IPO with a client. Chapman, a resident of Columbia, Maryland, was the former president and Chairman of the Board of The Chapman Company (TCC), a registered broker-dealer, and the former President, Director and control person
of Chapman Capital Management (CCM), an investment adviser registered
with the Commission.
Please click http://www.sec.gov/litigation/admin/34-52973.pdf to access a copy of the administrative order.
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SEC Issues Hedge Fund Adviser Rule Guidance
12.8.2005 SEC issued an interpretive letter to the American Bar Association Subcommittee on Private Investment Entities clarifying various issues raised by the hedge fund adviser registration rule.
Many of the issues addressed in the interpretive letter involved the two-year lock-up exemption, which allows advisers to avoid SEC registration if they do not allow their hedge fund investors to redeem their interests for two years. The SEC clarified the holding period. If an investor acquired interests in the hedge fund on January 1, 2007, the first date that investor could redeem his or her interest would be January 1, 2009 (not December 31, 2008). All owners of the hedge fund would have to be subject to the two-year redemption rule, including the adviser, general partner and knowledgeable employees of the adviser. The SEC also stated that transfers from one class of a hedge fund to another class, under limited circumstances, and redemptions at the master fund level in a master-feeder fund structure would not constitute a redemption within two years. The SEC clarified that on the two-year redemption anniversary, an investor would be able to redeem not only his or her original investment, but also gains and income and subsequent appreciation on those gains and income without constituting a redemption within two years. The SEC declined the ABA�s request that non-U.S. investors be exempt from the two-year lock-up rule.
The SEC stated that U.S. sub-advisers, like investment advisers, to hedge funds are subject to the hedge fund adviser registration rule, even if they only managed a small portion of the hedge fund�s assets. Under certain conditions, however, foreign sub-advisers to hedge funds would not have register with the SEC as investment advisers. The SEC set forth conditions for permitting special purpose vehicles formed by the adviser to a hedge fund to not have to register with the SEC. Hedge fund advisers sometimes set up a special purpose vehicle to act as the hedge fund�s general partner or managing member. The key condition is that employees of the special purpose vehicle would have to be associated persons of the registered adviser, and therefore subject to the registered adviser�s supervision.
The SEC elected not to exempt advisers to �family� hedge funds from the adviser registration rule. In addition, family members would count towards the 14 client limit.
The SEC stated that a hedge fund adviser could file its initial registration statement as late as January 9, 2006 and the SEC would act on it by the February 1, 2006 deadline.
The staff gave guidance on transactions between hedge fund, a percentage of which assets are owned by the adviser or affiliate, and other hedge funds and clients with respect to Section 206(3) of the Investment Advisers Act of 1940. That provision governs principal transactions between the adviser and its client. Lastly, the SEC provided guidance on the custody rule and recordkeeping rule, including maintaining records at the hedge fund�s administrator.
Please click http://www.sec.gov/divisions/investment/noaction/aba120805.htm to access a copy of the interpretive letter.
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SEC Proposes Rule Allowing the Delivery of Proxy Materials via the Internet
12.8.2005 The SEC proposed amendments to the proxy rules under the Securities Exchange Act of 1934 that would provide an alternative method for issuers and other persons to furnish proxy materials to shareholders by posting them on an Internet Web
site and providing shareholders with notice of the availability of the proxy materials.
Copies would be available to shareholders on request, at no cost.
Under the proposals, an issuer would be able to satisfy its obligations
under the SEC�s proxy rules by posting its proxy materials on a specified,
publicly-accessible Internet Web site (other than the Commission�s EDGAR Web site)
and providing shareholders with a notice informing them that the materials are available and explaining how to access those materials.
Shareholders and other persons conducting their own proxy solicitations would be
able to rely on the proposed amendments under requirements substantially similar to the
requirements that would apply to issuers. As a result, these proposals also would give
these shareholders and other persons an alternative method to furnish proxy materials that
may have the effect of reducing the cost of engaging in a proxy contest.
The proposed amendments would require an issuer that is relying on the proposed
�notice and access� model to provide a shareholder with a copy of the materials upon
request (in paper or by e-mail, as requested). A soliciting person other than the issuer
may choose not to provide a copy of its proxy materials to a requesting shareholder if the person is conducting a conditional �electronic only� proxy solicitation and soliciting
proxy authority only from shareholders willing to electronically access the soliciting
person�s proxy materials.
Please click http://www.sec.gov/rules/proposed/34-52926.pdf to access a copy of the proposing release.
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Adviser Charged with Cherry-Picking
12.2.2005 The SEC charged Gerson Asset Management, Inc. (GAM), a registered
investment adviser, and Seth Gerson, its sole owner, officer,
and employee, with �cherry picking� or the unfair allocation of trades.
Gerson operates GAM out of his home in Mount Kisco, New York.
The SEC order finds that from the time GAM commenced operations in
May 2000 through February 2004, Gerson unfairly allocated
profitable trades to his own accounts and allocated
unprofitable trades to the accounts of his advisory clients.
He did this by purchasing securities in an omnibus account and
delaying allocation of the purchases until later in the day,
after he saw whether the securities appreciated in value.
With respect to some clients, Gerson sold securities that had
appreciated and allocated the purchase and the realized day-
trading profit to his own account. With respect to a second
group of clients, Gerson sold securities that had appreciated,
allocated the day-trade and profit to his own account, and
then purchased the same security at the increased price for
the client�s account. As a result of this conduct, Gerson
realized ill-gotten gains of at least $200,000, and injured
his clients by at least $150,000.
The SEC order finds that Gerson
failed to create or maintain required records of client
trades, and that GAM�s Form ADV misrepresented that, in order
to protect against conflicts of interests, written records
would be maintained concerning trading by GAM�s employees and
related person in securities recommended to GAM clients.
Please click http://www.sec.gov/litigation/admin/34-52880.pdf to access a copy of the administrative action.
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SEC Brings Improper Performance Fee Case Against Adviser
12.1.2005 The SEC settled enforcement
proceedings against RENN Capital Group, Inc. (RENN Capital), a
registered investment adviser based in Dallas, Texas. The
Commission�s Order found that RENN Capital willfully violated
the performance-based-fee and proxy-solicitation provisions of
the federal securities laws and that it filed misleading
reports with the Commission. Between January 1996 and
December 2003, RENN Capital received excessive advisory fees
by improperly including unrealized capital appreciation in the
formula it used to charge performance-based fees to the
Renaissance Capital Growth & Income Fund III, Inc. (RenIII), a
registered business development company. RENN Capital also
failed to file a preliminary proxy statement in connection
with an amendment to the advisory contract with RenIII and
filed reports with the Commission on behalf of RenIII that
omitted material facts concerning the use of unrealized
capital appreciation in the calculation of the performance-
based fees that would have prevented statements in the reports
from being misleading.
Please click http://www.sec.gov/litigation/admin/ia-2454.pdf to access a copy of the administrative action.
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Hedge Fund Adviser Charged with Using Fraudelent PPMs
12.1.2005 The SEC charged Maxwell Investments, LLC, a registered investment
adviser, and Gary J. Maxwell, and Bart D. Coon, principals of
Maxwell Investments, with violating the antifraud,
adviser reporting and adviser recordkeeping provisions of the
federal securities laws. The SEC found that during 2003
Maxwell Investments, Gary Maxwell and Coon offered and sold
interests in several hedge funds operated by the firm through
private placement memoranda which misrepresented Maxwell
Investments� fee structure and made other material
misrepresentations. It further found that during 2003,
Maxwell Investments collected $839,798 in excess fees and
transferred assets between funds at various times without
disclosing these practices to investors. Further, the firm
failed to maintain proper books and records.
Please click http://www.sec.gov/litigation/admin/33-8640.pdf to access a copy of the administrative action.
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ETF Shares Required to be Reported by Access Persons
12.1.2005 The SEC in a no-action letter took the position that access persons of investment advisers must report their holdings of, and trades in, shares of exchange-traded funds (ETFs) that are organized as unit investment trusts (UITs). Most ETFs are organized as open-end investment companies and, as a result, are excluded from the definition of Reportable Securities under Rule 204A-1 under the Investment Advisers Act. However, many ETFs are organized as UITs, including SPDRs, MidCap SPDRs, Nasdaq-100 Shares, and DIAMONDS and their shares are subject to the reporting requirements.
In the no-action letter, the SEC staff recommended that investment advisers consider treating open-end ETF shares as Reportable Securities and that persons subject to the similar reporting requirements of Rule 17j-1 under the Investment Company Act of 1940 consider treating open-end ETF shares as "covered securities" when complying with the requirements of that rule. The staff recommendation, if followed, will require investment companies and investment advisers to revise their codes of ethics to require access persons to report ETF holdings and trades.
Please click http://www.sec.gov/divisions/investment/noaction/ncs113005.htm to access the no-action letter.
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