SEC-IA Settle Disclosure Case
It is fundamental that investment professionals accurately disclose their polices and procedures and adhere to them. Yet an increasing number of proceedings are being brought by based on failing to follow to those procedures. In the Matter of Equinox Fund Management, LLC, Adm. Proc. File No. 3-17057 (January 19, 2016) is the most recent example of this trend.
Equinox Fund Management is an asset management firm that specializes in managed futures. The firm is a registered investment adviser and a commodity pool operator. Equinox is the managing owner of The Frontier Fund, a managed futures fund, which operates as a series trust with numerous series engaged in separate trading strategies. The assets of each series are valued and accounted for separately.
Frontier Fund failed to adhere to disclosed policies and procedures regarding three key items:
Fees: One set of disclosures concerned the manner in which fees were charged. During the period from 2009 through 2011 Frontier Fund’s registration statements consistently stated that Equinox charged management fees based upon the NAV for each series. In fact, however, those fees were charged based on the notional assets being managed in each series. This refers to the trading level of the aggregate attributable assets that CTAs traded on behalf of each series.
In March 2011 Frontier Fund’s independent auditors questioned whether the fees were actually calculated based on the NAV for each series. Subsequently, Equinox modified Frontier Fund’s Form 10-K, filed in the first quarter of 2011, disclosing the method actually used to calculate the fees. The adviser did not refund the difference which meant it was overpaid about $5.4 million.
Valuation of derivatives: A second issue focused on the valuation for certain derivatives. Frontier Fund’s disclosures regarding its methodology for valuing certain derivatives was misleading. Specifically, its disclosures stated that in the first and second quarters of 2011 the value of certain derivatives was corroborated by weekly counterparty settlement values. In fact the adviser received information showing that the valuation of certain options was materially higher than that of the counterparty’s indicative settlement valuations. Indeed, Equinox received three specific types of information concerning the option counterparty’s pricing of the options which was materially different than the valuation of the options as reported by Frontier Fund.
Value of option: A third focused on the value of an option transferred between two series. Specifically, Frontier Fund’s Form 10-Q for the third quarter of 2011 stated the option was valued in accord with the disclosed policies. Those policies and procedures required that Equinox take into account the manner in which the same or similar securities held by other managed funds were valued in those funds. In fact an exception was made and the option was transferred at the valuation agent’s midpoint instead of the lower bound. In selecting that value Equinox failed to consider information regarding the same or similar securities held by other Frontier Fund series. In fact there was no justification for treating the transferred option differently.
Finally, Frontier Fund failed to disclose a material subsequent event. The applicable accounting standards require disclosure as a subsequent event when, for example, there are changes in the fair value of assets or liabilities after the balance sheet date but before the financial statements are issued or available to be issued. Here Frontier Fund’s Form 10-Q for the second quarter of 2011 failed to disclose the early termination of an option at a valuation that was materially different than what had been record. The option had been the largest investment of the series.
The Order alleges violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Section 13(a).
To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. The adviser will also pay disgorgement of $6,000,067, prejudgment interest and a penalty of $400,000.