On January 19, 2016, the SEC settled proceedings against a Denver-based asset manager for material misstatements made in the offer and sale of units of a publicly-registered managed futures fund. The SEC found that the manager disclosed that it charged the fund management fees based on the net asset value of each of the fund’s series when, in fact, the management fees were calculated based on the notional trading value (including leverage) of the assets in each series.
The manager is registered as an investment adviser with the SEC and as a commodity pool operator with the Commodities Futures Trading Commission. The SEC’s jurisdiction over the manager primarily stems from its registration as an investment adviser, although it was also found to have caused the fund to violate its reporting obligations (under the Securities Exchange Act of 1934) related to the fund’s securities registered under the Securities Act of 1933. The fund is a commodity pool and is not a registered fund under the Investment Company Act of 1940.
According to the SEC, the adviser calculated its management fees in a manner inconsistent with the method described in the fund’s registration statements and periodic reports. It also deviated from the disclosed valuation methodology for some of the fund’s holdings.
The SEC found that the adviser engaged in the following disclosure violations on behalf of the fund:
- The fund’s registration statements disclosed that the adviser charged management fees based upon the net asset value (NAV) of each series. However from 2004 to 2011, the adviser actually used the notional trading value of the assets (i.e., the total amount invested including leverage). This resulted in a $5.4 million overcharge to the fund by the adviser.
- The fund’s 2010 Form 10-K and 2011 Q1 and Q2 Forms 10-Q disclosed that its methodology of valuing certain derivatives was “corroborated by weekly counterparty settlement values.” According to the SEC, however, the adviser received information during that timeframe showing that its valuation of certain options was materially higher than the counterparty’s valuations.
- The fund’s 2011 Q3 Form 10-Q disclosed that an option had been transferred between two series consistent with the fund’s valuation policies. According to the SEC, however, the option was actually transferred using a different valuation methodology than substantially identical options held by other series.
- The fund’s 2011 Q2 Form 10-Q failed to disclose, as a material subsequent event, the series’ early termination of an option that constituted its largest investment at a materially lower valuation than had been recorded for that option.
To settle the proceedings, the adviser agreed to refund investors approximately $5.4 million in excessive fees collected, plus $600,000 in prejudgment interest accrued. In addition, the adviser agreed to pay a $400,000 civil penalty.
This case reinforces the need to ensure that funds carefully review their disclosure documents and ensure that internal policies and procedures are consistent with their stated disclosure. In addition, and as we noted in our post about OCIE’s 2016 priorities, although OCIE dropped its explicit focus on alternative investment companies from this year’s priorities list, it would be prudent to assume that OCIE will continue to focus on alternative funds, especially in light of the recent rule proposal on funds’ use of derivatives.