In the December 2012 edition of our Investment Management Update, we reported on an SEC enforcement matter involving a hedge fund manager who “cherry picked” investments over the interests of its clients. This past month, the SEC settled an enforcement matter (In the Matter of Middlecove Capital, LLC and Noah L. Myers, Investment Advisers Act of 1940 Release No. 3534 January 16, 2013), which included similar allegations against a Connecticut-based investment advisory firm and its principal owner and chief investment officer.
At its peak, the firm, which is no longer registered as an investment adviser under the Advisers Act, had about $129 million of assets under management for more than 350 clients. During the adviser’s existence, it was not uncommon for the firm to trade for its own account alongside its client accounts. However, for a period of about two and a half years, the adviser engaged in a cherry-picking scheme in which its own and those of the firm’s principals’ accounts were allocated profitable trades and client accounts were allocated unprofitable trades. During that period of time, one of the principal’s trading accounts had a track record where 95 percent of the trades were profitable, a result that could only suggest fraudulent conduct. According to the SEC’s calculations, time and time again, clients lost money in the same positions when the adviser’s and its principals’ accounts profited or did not lose money from trades in such positions.
This matter was recently settled when the respondents agreed to a cease and desist order from engaging in fraudulent behavior under the Securities Exchange Act of 1934 and the Advisers Act, a bar imposed on the firm’s principal from association with, among others, any investment adviser, and from acting or serving as an employee, officer, director, or member of an investment adviser or investment company. The firm and its principal also were ordered to pay disgorgement of $462,022 plus interest of $26,096 and a civil penalty of $300,000.