The SEC has charged hedge fund manager Lawrence Goldfarb with diverting for himself and his related entities approximately $12 million of investment proceeds that belonged to the investors in a hedge fund he managed.

According to the SEC's complaint, filed in federal district court (SEC v. Lawrence R. Goldfarb, et al., CV-11-0938-DMR, 3-1-2011, filed in U.S. Dist. Ct. for Northern District of California) Mr. Goldfarb and his company, Baystar Capital Management LLC, diverted the $12 million to other entities he controlled and commingled investor funds in a bank account he used to pay his personal expenses. According to the SEC, Mr. Goldfarb was able to carry out the fraud because the investment for the hedge fund was made in a “side pocket.” A side pocket is generally used by a hedge fund manager to isolate an investment from the other assets of the hedge fund due to the illiquid nature of the investment. Although the side investment was profitable, Mr. Goldfarb diverted the proceeds for his related entities' uses rather than applying those proceeds to the fund and its investors. Mr. Goldfarb has agreed to pay more than $14 million to settle the SEC's charges.

According to the SEC, Mr. Goldfarb managed to conceal the fraud for several years by providing written statements to the fund's investors showing that no gains had been realized in the side pocket investment although that was clearly erroneous. According to the SEC, Mr. Goldfarb also acted to hide the true results of the side pocket investment from the fund's administrator.

In addition to the payment of the $14 million, Mr. Goldfarb agreed to a permanent injunction, payment of $130,000 in penalties, and being barred from association with an investment adviser for five years.