Whistleblower Awards for Exposing Hedge Fund Fraud
Under the SEC Whistleblower Program, whistleblowers may be eligible for monetary awards when they provide the SEC with original information about violations of federal securities laws, including hedge fund fraud. Whistleblowers are eligible to receive between 10% and 30% of the monetary sanctions collected if their tip leads to a successful enforcement action resulting in monetary sanctions exceeding $1,000,000.
Since 2011, the SEC Whistleblower Office has awarded more than $150 million to whistleblowers. In FY 2016 alone, the office issued more than $57 million in awards to whistleblowers. While hedge funds are not required to abide by all of the strict regulations that apply to mutual funds, hedge funds are still subject to the same prohibitions against fraud as are other market participants.
Overview of Hedge Funds
Like mutual funds, hedge funds pool investors’ money and invest the money. Hedge funds, however, are not subject to some of the regulations that apply to mutual funds that are designed to protect investors. As such, hedge funds lend themselves to more flexible and risky investments strategies (not often used by mutual funds), such as using leverage, short-selling, derivatives and other speculative investments.
Moreover, certain federal and state laws that apply to mutual funds do not apply to hedge funds. For example, the SEC notes that “hedge funds are not required to provide the same level of disclosure as you would receive from mutual funds. Without the disclosures that the securities laws require for most mutual funds, it can be more difficult to fully evaluate the terms of an investment in a hedge fund. It may also be difficult to verify representations you receive from a hedge fund.”
Examples of Hedge Fund Fraud
Notable areas of hedge fund fraud that may qualify for an SEC whistleblower award include:
- Material Misrepresentations to Investors;
- Misappropriation of Investor Funds/Ponzi Schemes; and
- Insider Trading.
See below for examples of SEC enforcement actions brought against hedge funds for these violations.
SEC Actions Combatting Hedge Fund Fraud
Material Misrepresentations to Investors
Generally, hedge funds do not calculate performance in the same manner as mutual funds because hedge funds can invest in securities that are relatively hard to value. In contrast, federal securities laws heavily dictate mutual funds by requiring specific methods on how to advertise their performance data and disclosures. Because of the difference in calculating performance, the SEC has closely monitored hedge fund practices for fraudulent performance.
• SEC v. Beacon Hill Asset Management Company: The SEC charged hedge fund Beacon Hill and its four principals for implementing a fraudulent scheme that resulted in investors losing more than $300 million. According to the SEC’s complaint, the hedge fund’s principals made several material misrepresentations to investors, including: (1) the methodology it used for calculating the net asset values of the hedge funds it managed; (2) its hedging and trading strategy; and (3) how it valued the performance of the funds. In addition, the SEC alleged the hedge fund manipulated its valuation procedures to show steady and positive returns.
• SEC v. Charles L. Harris, Tradewinds International L.L.C. and Tradewinds international II L.P.: The SEC charged hedge fund Tradewinds International with fraudulently raising $10 million from at least 30 investors by misrepresenting the fund’s past rates of return, net asset value and the use of investor funds. According to the SEC’s complaint, the hedge fund manager, Charles L. Harris, told investors that Tradewinds’ net asset value was between $18 and $23 million, when in reality it was approximately $30,000. Harris was sentenced to 168 months in prison and was ordered to pay restitution of $13.8 million.
• SEC Investigates Statim Holdings Inc.: The SEC is currently investigating Statim Holdings Inc., an Atlanta-based firm that has allegedly guaranteed positive returns to investors in its main hedge fund. Note: To date, the firm has not been accused of any wrongdoing and an investigation doesn’t mean they will face legal action.
Misappropriation of Funds and Ponzi Schemes
Section 206 of the Investment Adviser Act of 1940 (IAA) prohibits fraudulent and deceptive conduct. Misappropriation is the intentional and illegal use of property, or funds of another person for their own use, or other unauthorized purpose. In addition, the SEC defines a Ponzi scheme is “an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors.” Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk.
• SEC v. Yasuna Murakami. MC2 Capital Management, LLC: On May 22, 2017, the SEC charged a Massachusetts-based hedge fund manager, Yasuna Murakami, with making “Ponzi-like payments and taking investor funds to pay for personal travel, meals, and credit card bills.” According to the SEC’s complaint, Murakami misappropriated more than $8 million for business and personal expenses and made approximately $1.3 million in Ponzi-like payments to earlier investors as purported investment gains. The enforcement action led to at least $10 million in monetary sanctions.
Hedge funds are liable for insider trading violations when they buy or sell a security in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security.
• SEC v. S.A.C. Capital Advisors: In March 2013, hedge fund advisory firm CR Intrinsic Investors – an affiliate of S.A.C. Capital – agreed to pay more than $600 million for allegedly participating in an insider trading scheme involving a clinical trial for an Alzheimer’s drug being developed by a pharmaceutical company. According to the SEC’s complaint, two of the firm’s portfolio managers, Mathew Martoma and Michael Steinberg, illegally obtained confidential information about the clinical trial’s negative results about two weeks before they were made public. The portfolio managers then tipped off several hedge funds about the negative results. In a little more than a week, several hedge funds sold nearly $1 billion of the pharmaceutical company’s stock.
The hedge funds earned profits and avoided losses of more than $275 million as a result of the illegal trades. Martoma was rewarded with a $9 million bonus for his work.
The SEC Whistleblower Program also protects the confidentiality of whistleblowers and does not disclose information that might directly or indirectly reveal a whistleblower’s identity. Furthermore, the Dodd-Frank Act protects whistleblowers from retaliation by their employers for reporting violations of securities laws.
Whistleblowers may file a tip with the SEC anonymously if they are represented by an attorney.
Experienced SEC Whistleblower Attorneys
To learn more about the SEC Whistleblower Program, download Zuckerman Law’s eBook: SEC Whistleblower Program: Tips from SEC Whistleblower Attorneys to Maximize an SEC Whistleblower Award:
See our column in Forbes: One Billion Reasons Why The SEC Whistleblower-Reward Program Is Effective
See our column in Going Concern: Sarbanes-Oxley 15 Years Later: Accountants Need to Speak Up Now More Than Ever