Peeking At Cards

Hedge Fund Shenanigans Uncovered by the SEC

Peeking At Cards

While perusing the Wall Street Journal, we came across an article1 (“SEC Criticizes Hedge Funds”) that caught our attention. The Securities and Exchange Commission (SEC) recently completed examinations of 185 hedge fund firms and found deficiencies such as firms boosting their performance and the fees they collect by changing the way they value investments.

Andrew Bowden, director of the SEC’s Office of Compliance Inspections and Examinations, said that some funds were engaging in “flip-flopping,” which refers to using one valuation technique when an asset is purchased and then switching to a different technique when it is valued at the end of a quarter, resulting in an abnormally high gain and thus a higher fee for the manager.

The underlying problem is that hedge funds often hold assets that do not have a clear cut market value. Examples of these types of assets include real estate, private equity, and distressed debt. These assets can also pose liquidity problems when the hedge fund is faced with redemption requests. For these assets, the SEC does not dictate any particular valuation method, but it does expect fund companies to precisely disclose to investors how they value these assets and to act consistently with their stated methodologies.

Without getting into specific details, Mr. Bowden also stated that marketing and advertising issues were uncovered. Only about a year ago was the ban on hedge fund advertising lifted by the SEC. In doing a Google search, we were able to find one advertisement that showed some snowboarders with the caption, “performing in all conditions.” We can see how the SEC may have a problem with the implication that investors can expect high returns regardless of what occurs in the financial markets. According to this Reuters article, the SEC also identified the problem of “cherry-picking” when hedge funds choose to showcase the performance of specific investments they made.

Compared to the cases of insider trading and outright fraud that we have discussed in past articles such as this one, these violations are definitely on the mild side. However, the SEC has issued other warnings about hedge funds such as the ones we wrote about here. If you are considering or currently invested in a hedge fund and would like to discuss it with a fiduciary wealth advisor, please give us a call at 888-643-3133.

1Ackerman, Andrew and Copeland, Rob. “SEC Criticizes Hedge Funds”, Wall Street Journal, 9/23/2014, page C5.