On October 17, the SEC filed a lawsuit in the Southern District of New York against hedge fund Yorkville Advisors LLC, as well as its President Mark Angelo and CFO Edward Schinik.  The action, brought by the SEC’s Asset Management Unit, is the latest alleged fraud brought to light by its “Aberrational Performance Inquiry,” which uses risk analytics to identify returns from hedge funds that appear to be too good to be true.

The Inquiry focuses on identifying problems by using a series of performance metrics to assess the performance of a hedge fund, and has resulted in six earlier cases.  Performance that is flagged as inconsistent with a fund’s investment strategy or other benchmarks forms a basis for further investigation and scrutiny.

"The analytics put Yorkville front and center on our radar screen,” said Bruce Karpati, Chief of the SEC Enforcement Division’s Asset Management Unit. The SEC alleges that Yorkville and the two executives failed to stick to the fund’s stated valuation policies, ignored negative information about certain investments, withheld information from the fund’s auditor, and misled investors about the liquidity of the funds and the collateral underlying the investments.

Fund managers may be motivated to inflate the value of their funds because their management fees are tied to the value of assets under management.  According to the complaint, “as a result of the inflated value of such investments, Yorkville improperly received more than $10 million of unearned fees from the Funds.”

As noted above, this is the seventh case arising from the SEC’s Aberrational Performance Inquiry.  A series of those cases were filed in November and December 2011, including cases against Millennium Global Emerging Credit Fund and its principles for manipulating its supposedly independent valuation process, and against ThinkStrategy Capital Management LLC and its managing director for engaging in deceptive conduct designed to bolster its track record, size and credentials.

According to Mr. Karpati, the SEC has brought more than 100 enforcement actions related to hedge fund firms.  Under the Dodd-Frank Act, the SEC now requires hedge fund managers and other advisers of private equity funds to register with the agency, many for the first time.  Companies that insure these risks should be aware of the uptick in regulatory and enforcement actions already happening and promised for the future.

The SEC’s press release regarding the Yorkville matter can be found here.  Its complaint can be found here.