Fraud cases involving investment funds frequently focus on claims that the defendants operated a Ponzi scheme. Following the Madoff debacle, dozens of Ponzi scheme cases have been brought. Most follow a familiar pattern, centering on bogus claims to investors about huge returns for a safe investment. Consider, for example, the case of U.S. v. Moore (S.D.N.Y.) in which the defendant pleaded guilty to nine counts of wire fraud and one count of conspiracy to commit wire fraud on October 19, 2010. There, the defendant and his co-conspirator are alleged to have raised over $80 million from investors who thought they were buying interests in ATMs which would generate profits from fees for withdrawals of cash. There were no ATMs, of course, but Mr. Moore and his partner grew rich, at least for a time, while investors lost.

Investors also lost in the Commission’s latest case investment fund case, SEC v. Mannion, Civil Action No. (N.D. Ga. Filed Oct. 19, 2010). This action may, however, suggest the type of investment fund cases to come from the dozens of market crisis investigations underway.

Mannion centers on claims that fund managers made a bad investment which they tried to conceal to avoid a run of redemptions. The defendants are Paul T. Mannion, Jr., Andrew Reckles and PEF Advisors LLC. Messrs. Mannion and Reckless are the principals and co-owners of PEF Advisors LLC and PEF Advisors Ltd., investment advisers to the feeder funds of Palisades Master Fund, L.P.

Messrs. Mannion and Reckless materially overvalued fund assets, thereby deceiving investors and inflating their fees, according to the SEC. Beginning in August 2004, the individual defendants invested about 20% of the Fund’s assets in the securities of World Health Alternatives, Inc., a medical staffing company. Throughout the spring and summer of 2005, Messrs. Mannion and Reckless sold more than $12 million in World Health shares for their personal accounts.

In the summer of 2005, World Health was experiencing financial difficulties. The Fund extended a $4 million bridge loan to the company. Nevertheless, its financial condition continued to deteriorate. Messrs. Mannion and Reckless sold large positions in the company from their personal accounts. The Fund, however, continued to hold its World Health position despite the fact that by the end of August 2005 it was apparent the company would be unable to repay its bridge loan.

To avoid the risk of large scale redemptions, the defendants decided to place the World Health assets in what is called a “side pocket.” This device is used by hedge funds to separate typically illiquid investments from more liquid ones. It also limits redemptions. Investors cannot typically redeem that portion of their shares which relates to the illiquid assets in the side pocket.

Messrs. Mannion and Reckless requested consent from some shareholders to use a side pocket for World Health in a letter. It told shareholders that the total Fund investment was about $19.2 million. It did not tell shareholders about the deteriorating financial condition of the company. The day after the letter was sent, the two individual defendants sold all of their remaining unrestricted shares in World Health.

In subsequently calculating NAV, the defendants failed to follow their disclosed valuation policies. If those policies were followed as to World Health, for example, it would have been valued at $0 rather than the $1.9 million reflected in the calculations. The valuation of other holdings also failed to follow the disclosed policies. The inflated NAV was used to solicit other investors and calculate the management fees payable to Messrs. Mannion and Reckless.

Eventually, World Health declared bankruptcy. At that point, the assets held in the Fund side pocket were reduced to a value of $0.

During the same period Messrs. Mannion and Reckless also stole Fund assets according to the complaint. Specifically, they exercised World Health warrants the Fund obtained in connection with the bridge loan and took the profits for themselves. They also improperly used Fund assets to pay for certain expenses.

Finally, the complaint alleges that in connection with a PIPE offering by Radyne Corporation in February 2004, Messrs. Mannion and Reckless made material misrepresentation. The two men represented to the promoters that they would not trade in the underlying shares when informed about the offering and then sold those shares short.

The complaint alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). The case is in litigation. See also Litig. Rel. 21699 (Oct. 19, 2010).