The Securities and Exchange Commission has charged two Minnesota-based hedge fund managers and their firm for facilitating the multi-billion dollar Ponzi scheme operated by Minnesota businessman Thomas Petters.

In its complaint, the SEC alleges that fund managers James Fry and Michelle Palm, with Fry’s firm Arrowhead Capital Management, invested some $600 million in hedge fund assets with Petters, collecting over $42 million in fees in the process.

Meanwhile, they “falsely assured investors and potential investors that the flow of their money would be safeguarded by the operation of certain collateral accounts when, in fact, the process did not exist as described,” the Commission says.

This is the fourth enforcement action the SEC has brought against feeder funds to the Petters Ponzi scheme, previously charging two Florida-based managers and one manager based in Illinois.

“Fry and Palm presented themselves as protectors of their hedge fund investors when in fact they were facilitators of the Petters Ponzi scheme,” said Merri Jo Gillette, director of the SEC’s Chicago regional office. “Arrowhead’s promises were filled with lies and deceit, and as a result investors lost more than $600 million dollars while Fry pocketed millions in fees.”

According to the SEC’s complaint, Petters was running a “purchase order inventory financing” scam, in which he promised investors that their money would be used to finance the purchase of large orders of consumer electronics by vendors, who would then sell this on to retailers such as Wal-Mart and Costco. However, the fund was in reality operating as a Ponzi scheme.

Petters sold promissory notes to hedge funds, including Arrowhead Capital, the SEC alleges. The firm’s funds were holding $600 million worth of Petters’ notes when the Ponzi scheme collapsed, according to the Commission.

The complaint alleges that Fry, Palm and Arrowhead Capital falsely represented to investors that the inventory financing transactions were structured in such a way that upon delivery of the merchandise to retailers, their payments would be sent directly to the funds’ collateral accounts to pay off the promissory notes.

Furthermore, Fry, Palm and the firm hid the fact Petters was on the verge of defaulting and engaged in secret extensions of the notes without telling investors, according to the SEC’s statement.  

The hedge fund manager duo have also been charged criminally over the same misconduct, and Palm has pleaded guilty to one count of securities fraud and one count of making false statements to SEC staff during investigative testimony. Fry pleaded not guilty to multiple counts of securities fraud, wire fraud, and making false statements to SEC staff during investigative testimony.