High Risk Trading Program Yields Billion Dollar Loss

Risk is a fundamental of investing. Assessing the risk of a particular investment can be the make or break point as to whether to proceed or not. Some investors are largely risk adverse, looking for sound but conservative and largely riskless investments. Others go to the other extreme, investing in extremely high risk investments. In the most recent case involving risk brought by the Commission, investors knew that the investments were risky. Until the losses totaled over a billion dollars in two days, however, they had no idea just how large the risks were – their advisers concealed them. SEC v. Caine, Civil Action No. 1:21-cv-02859 (N.D. Ill. Filed May 27, 2021).

The action named as defendants: Anthony Caine, the founder, owner and Chairman of both entity defendants; Anish Parvataneni, co-portfolio manager for P&G Fund and the private funds; LJM Funds Management, LTD., a registered investment adviser until 2018; and LJM Partners, LTD., an investment adviser to several, related private funds.

Defendant Caine is the author of a short-term investment strategy used by LJM Funds and LJM Partners. The strategy involved writing (selling) short-dated out-of-the money options on S&P 500 futures contracts known as short options or short volatility trading. The approach, could generate stable profits, but in the late stages carried risk of significant losses during large market swings. Investors were offered three variations of the strategy.

LJM had a risk officer. The firm materials also addressed the subject of risk. The firm, however, had no real integrated risk control framework except one: Ownership had the last word – Mr. Caine. Nevertheless, LJM touted risk analysis in its marketing. Mr. Caine admitted in an e-mail, however, that the “immediate straight answers to these questions [on risk] are ugly . . .Real ugly. Hell I would run.”

Investors were not told to run. To the contrary, Defendants created a marketing narrative, talking points and other materials; investors were told to come on down because the firm had sophisticated risk management procedures to handle their investment portfolios and control risk.

The risk management message was repeatedly communicated in literature, emails and other papers, some of which even including claims about “worst-case-scenario-based stats.” The papers also told potential investors that the portfolios were stress tested against specific historical scenarios to estimate worst-case daily loses; worst-case daily losses were estimated; and the funds were managed to maintain consistent risk levels. And there was more, much more, all designed to reassure investors that risk from the trading policies was managed and under control.

Not only were investors not told the actual risks, in 2017 and early 2018 the firm increased the risk in an effort to achieve targeted returns. In February 2018 the financial markets suffered a large spike in volatility over two consecutive trading days. The funds managed by LJM and LJM Partners suffered trading losses of over $1 billion.

The complaint alleges violations of Securities Act Section 17(a), Exchange Act Sections 10(b) and 20(a), Advisers Act Sections 206(1), 206(2) and 206(4) and Investment Company Act Sections 15(c) and 34(b). In a related proceeding Arjuna Ariathural , LJM’s Chief Risk Officer agreed to be barred with the right to apply for reentry after three years. He also agreed to pay disgorgement and prejudgment interest of $97,444 and a civil penalty of $150,000. See Lit. Rel. No. 2510 (May 28, 2021).

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