HEDGE FUND MANAGER SETTLES WITH SEC AND USAO
Lawrence Goldfarb, the manager of a successful hedge fund, and the fund he managed, settled charges with the SEC and the U.S. Attorney’s Office stemming from his diversion of over $12 million from a side pocket investment of the fund. Investors knew that the assets had been placed in the side pocket but were not told that the investment was profitable. SEC v. Goldfarb, CV-11-0938 (N.D. CA. Filed March 1, 2011); U.S v. Goldfarb, CR 110099 (N.D. CA. Filed March 1, 2011).
Mr. Goldfarb has been the manager of Baystar Management, LLC since 2001. Baystar is the investment adviser to a private investment fund, Baystar Capital II, L.P. In 2004 the fund held assets of about $100 million. In 2003 fund made an $8.4 million investment in Island Fund Investment, a limited liability company which invests in real estate. Mr. Goldfarb put the investment in a side pocket, a device intended to hold what are viewed as illiquid investments. Typically these investments are only redeemed upon disposition of the assets in the side pocket. When the redemption occurs the proceeds are to be distributed among share holders on a pro rata basis.
Fund investors were aware that the Island Fund investment was being held in a side pocket. Repeatedly over a period of years they asked Mr. Goldfarb about the investment which, under the fund rules was valued at cost. In each instance the investors were told that the investment remained in the side pocket. Indeed, Mr. Goldfarb even furnished investors with statements showing the no gains had been realized on the investment.
In fact the investment began to generate revenue the year after it was purchased. Mr. Goldfarb did not disclose this fact to fund investors. Rather, beginning in 2007 he diverted revenue from the investment to other investments and his personal use. Portions of the funds were put in a separate real estate fund. Other portions were diverted private companies. Portions of the proceeds were deposited into the bank account of one of Mr. Goldfarb’s related entities which he used to pay for unauthorized personal expenses. Overall about $12 million was diverted. None of these transactions were authorized by the fund’s offering documents. The SEC’s compliant against Mr. Goldfarb and Baystar Capital alleges violations of Advisers Act Sections 206(1), (2) and (4).
To settle with the SEC Mr. Goldfarb consented to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. He also agreed to pay disgorgement of $12,112,416 along with prejudgment interest and to pay a civil penalty of $130,000. In addition Mr. Goldfarb agreed to be barred from associating with any investment adviser or broker, with a right to reapply in five years, and to be barred from participating in any offering of penny stock.
In a related criminal proceeding Mr. Goldfarb and Baystar were charged in a one count information alleging wire fraud. To resolve this action the defendants entered into a deferred prosecution agreement with a term of three years. Under the terms of that agreement Mr. Goldfarb is to make restitution in accord with the terms of his settlement with the Commission. He will also be barred from the securities business for three years.