by T. GormanPosted on Posted in SECActions

The SEC’s Aberrational Performance Inquiry resulted in another case this week. The action named as defendants prominent hedge fund manager Yorkville Advisor, LLC and two of its principals Mark Angelo and Edward Schinik. SEC v. Yorkville Advisors, LLC, Civil Action No. 12 CIV 7728 (S.D.N.Y. Filed Oct. 17, 2012). The Aberrational Performance Inquiry is a joint project of the Enforcement Division’s Market Abuse Unit and the Office of Compliance, Inspections and Examinations and the Division of Risk, Strategy and Financial Innovation. It focuses on identifying areas of inquiry by using a series of performance metrics to assess the performance of a hedge fund. The Inquiry has resulted in six earlier cases.

Yorkville is a registered investment adviser founded by Mr. Angelo. Mr. Schinik served as CFO and COO. It managed the YA Global Investments (U.S.) LP fund, the YA Offshore Global Investments, Ltd. fund and the YA Global Investments, LP fund. Generally the investment strategy called for funds to be put into privately negotiated structured equity and debt in public and private companies. It provided alternative financing for microcap and small-cap publicly traded companies. The investments were structured in various forms including convertible securities, standby equity distribution agreements and convertible preferred securities. An important part of the profits achieved came from sale of securities obtained as part of the overall investment.

Yorkville’s ability to understand the valuation of its investments was critical to its strategy and results. The PPM given to investors specified that GAAP would be followed in calculating the net worth of each fund. Yorkville’s internal policies also required it to mark the funds’ investments at fair value. Until the market crisis the adviser used a valuation method it called in pitch maters the “Yorkville Method” which it claimed was GAAP compliant.

As the market crisis unfolded Yorkeville had difficulty liquidating securities it obtained from the investments. In 2008 the adviser altered its branded valuation method, adopting a new approach. While it claimed that the new method was GAAP compliant in fact it was not, according to the complaint. Under the new method most of the convertibles were simply carried at face value rather than at current, fair and accurate valuations as required. No testing was done to validate the values. Indeed, the values of the collateral underlying the convertibles were unknown. As a result Yorkville overvalued a series of investments by at least $50 million as of December 2008 and $47 million as of the end of December 2009. The supporting documentation of the defendants reflected these over valuations, according to the complaint. These over valuations inflated the value of the funds which attracted investors as well as the fees that Yorkville charged.

Misrepresentations were also made to prospective investors to lure them into putting their money in the funds. Those concerned the collateral underlying certain securities obtained as investments, the liquidity of the Funds and their internal procedures.

The complaint alleges violations of each subsection of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisors Act Sections 206(1) and (2) and 204(4). It also alleges control person liability under Exchange Act Section 20(a). The case is in litigation. See also Lit. Rel. No. 22510 (Oct. 17, 2012).

Tagged with: ,

by T. GormanPosted on Posted in SECActions

High speed traders are a topic of much debate these days. By most reports they are a significant part of the markets. Those markets have become increasingly volatile. Many think that technology may be playing a part. There has been the “flash crash,” a programming glich at Knight Capital, difficulties on the NASDAQ related to trading in Kraft Foods, issues on the Tokyo Stock Exchange and others. All of this has lead to numerous media reports, Congressional hearings and roundtable discussions by regulators.

Now, as regulators continue to struggle with the implementation of Dodd-Frank, and market participants gulp to digest the changes, there are calls for a new round of regulation aimed at high speed trading. CFTC Commissioner Bart Chilton, addressing the 2012 Allegro Customer Summit in Dallas, Texas on October 16, 2012, outlined a proposal for regulating such trading in remarks titled “Texas Hold ‘Em – Time to Fold ‘Em” (here).

The Commissioner began by developing a theme that would run through his presentation regarding the role of speculators and regulation. While Texas Hold ‘Em may be time honored in the town of Robstown, Texas, officially recognized as the home town of the game, and speculators may have a valid role in the markets – even high speed traders – that does not mean that regulation is inappropriate. Reminding us that then Treasury Secretary Hank Paulson one stated that leading up to the market crash of 2008 there was insufficient regulation because “No one wanted it. We were making too much money,” the Commissioner recounted the accomplishments of Dodd-Frank in five key points:

  • Transparency was brought to markets where there was little;
  • Systemic risk has been lowered;
  • Accountability has been brought to markets that often had little; and
  • Integrity had been increased in the markets.

Dodd-Frank does not mention computerized trading however. As Commissioner Chilton noted, the Act was signed into law just after the flash crash. The prospects for market disruption by the specter of millions of shares being traded in milliseconds require that there be at least some governing regulation. The “fix,” according to the Commissioner, is a six part proposal:

  1. Registration: High speed traders should register as a “pedestrian first step;”
  1. Testing: Traders should be required to test their programs before they are “unleashed in a live production” which is something many do now;
  1. Kill switches: Traders should be required to have a kill switch in the event something goes wrong – a proposal the SEC and CFTC are currently working on;
  1. Wash blocker technology: There should be pre-trade controls which prevent the traders from engaging in wash or cross trades with themselves which are already illegal;
  1. Compliance reports: Traders and their officers should be required to execute compliance reports and be accountable for false or misleading information; and
  1. Penalties: Traders should be accountable in damages for any loses they cause from rogue activities.

Moving forward with new regulations while still struggling with the older ones is perhaps a natural part of ever evolving markets in which regulators struggle to keep up and then market participants work hard to figure out how to participate under a new regulatory regime. While all this is going on, however, it is good to remember that tomorrow’s markets still begin with fundamental fairness today. That point should be clear from the Commission’s recent action against the New York Stock Exchange which for years gave informational advantages to select customers. If the public is going to trust the nation’s capital markets it all begins with making sure that the investing public is playing in a fair game, not one in which the dealer has an ace up his sleeve. If the game is not actually and perceived to be fair, its time to fold ‘em.

Tagged with: , ,