The Securities and Exchange Commission is taking enforcement actions against three advisory firms and six individuals for misconduct, including improper use of fund assets, fraudulent valuations and misrepresenting fund returns. The firms implicated are ThinkStrategy Capital Management, Solaris management and LeadDog Capital Markets.

The firms and managers involved engaged in “a wide variety of illegal practices” in the management of hedge funds and private pooled investment vehicles, the SEC alleges. These include: fraudulent valuation of portfolio holdings, misuse of fund assets, and misrepresentations to investors about critical attributes such as performance, assets, liquidity, investment strategy, valuation procedures, and conflicts of interest. Three actions have been filed in federal court and one has been brought up as an administrative proceeding.

A host of firms, individuals charged

The SEC has charged Michael Balboa and Gilles De Charsonville for overvaluing reported returns and net asset values of the Millennium Global Emerging Credit Fund, the assets of which peaked at $844 million in October 2008.

Through manipulation of its independent valuation process, Balboa, Millennium’s former portfolio manager, schemed with two European-based brokers, including De Charsonville of BCP Securities, to inflate the fund’s reported monthly returns and net asset values, the regulator says.

From January to October 2008, Balboa provided De Charsonville and another broker with fictional prices for two of Millenium’s securities holdings to be passed on to Millennium’s outside valuation agents and auditor, according to the SEC’s complaint. The scheme resulted in an overvaluing of the securities holdings by up to $163 million in August 2008. This allegedly resulted in Balboa attracting $410 million in new investments, the deterrence of around $230 million in eligible redemptions, and the generation of millions in management and performance fees.

Separately, Balboa has been arrested by the US Attorney’s Office for the Southern District of New York and a criminal action has been filed against him.

In another case, ThinkStrategy Capital Management, a New York-based hedge fund, and its managing director Chetan Kapur have been charged with fraud in connection with the ThinkStrategy Capital Fund and the TS Multi-Strategy Fund, two separate hedge funds the firm managed. ThinkStrategy managed around $520 million in assets at its peak in 2008.

In a complaint filed on 9 November, the SEC alleges that ThinkStrategy and Kapur conducted activities designed to boost their track record, size, and credentials. According to the SEC, they overstated the performance of the ThinkStrategy Capital Fund and gave investors a false impression that the fund’s returns were consistently positive with minimal volatility. They also allegedly inflated the firm’s assets, exaggerated the firm’s longevity and performance history, and misrepresented the firm’s management team.

ThinkStrategy and Kapur have agreed to pay penalties – still to be determined by a federal court - and have consented to the entry of judgments permanently enjoining them from violating the antifraud provisions of the securities laws. Kapur has been barred from association with any investment advisor, broker, dealer, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organizations.

Meanwhile, Patrick Rooney and his company Solaris Management have been charged by the SEC for fraudulently misusing the assets of the Solaris Opportunity Fund. Contrary to documents offered by the firm and marketing materials, the fund became wholly invested in Positron, a financially troubled microcap company.

Finally, the SEC instituted administrative proceedings against LeadDog Capital Markets, an unregistered investment advisor, and its general partners and owners Chris Messalas and Joseph LaRocco, for misrepresenting and failing to disclose information to investors.

The “Aberrational Performance Inquiry”

The actions are part of an initiative called the “Aberrational Performance Inquiry” which the Commission says will see it combat hedge fund fraud by using proprietary risk analytics to identify returns that appear inconsistent with a hedge fund’s strategy and then scrutinizing these further.

“The extraordinary returns reported by these advisors and portfolio managers were, in most cases, too good to be true. In other cases, outlier returns were a telltale sign that something else was amiss. We are applying analytics across the investment advisor space – beyond performance and beyond hedge funds,” said Robert Kaplan and Bruce Karpati, co-chiefs of the SEC Enforcement Division’s asset management unit.

“We’re using risk analytics and unconventional methods to help achieve the holy grail of securities law enforcement — earlier detection and prevention,” said Robert Khuzami, director of the SEC’s Division of Enforcement.

“This approach, especially in the absence of a tip or complaint, minimizes both the number of victims and the amount of loss while increasing the chance of recovering funds and charging the perpetrators,” he added.