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Vedder Thinking | Articles Recent SEC Enforcement Actions Signal Shift to More Proactive Approach to Hedge Fund Regulation


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Several enforcement actions announced by the SEC in recent months appear to be products of a specific Division of Enforcement initiative—dubbed the “Aberrational Performance Inquiry”—designed to identify abnormally high-performing hedge funds and target them for increased scrutiny. Under this new initiative, the Division of Enforcement’s newly established Asset Management Unit has begun using proprietary risk analytics to evaluate hedge fund returns, focusing primarily on performance that appears inconsistent with a fund’s investment strategy or other benchmarks. While details regarding the exact analytics being used have not been made available, SEC Director of Enforcement Robert Khuzami has stated that the Asset Management Unit is focusing on hedge funds that are outperforming market indexes by 3 percent on a steady basis. 

On December 1, 2011, the SEC announced several recent enforcement actions that appear to have arisen from this new initiative. The complaints in all three of the newly initiated actions allege a variety of securities violations and other illegal practices, including, among others, inflating the value of fund holdings, concealing fund performance and intentionally misrepresenting key fund characteristics, including assets, liquidity, investment strategy, manager credentials and conflicts of interest.

In SEC v. Balboa, No. 11-CV-08731 (S.D.N.Y. 2011), the SEC alleged that Balboa, a former portfolio manager, conspired with two European brokers in a fraudulent scheme to inflate the hedge fund’s reported monthly returns and net asset value by manipulating the valuation process. According to the complaint, Balboa provided fictional prices for two of the fund’s illiquid holdings, which in turn allowed the fund to drastically overvalue certain of its securities holdings and report inflated and falsely positive monthly returns.

In SEC v. Rooney, No. 11-CV-08264 (N.D. Ill. 2011), the SEC alleged that Rooney, an investment advisor to the Solaris Opportunity Fund LP, made a drastic change in the fund’s investment strategy that was inconsistent with the fund’s offering documents and marketing materials by becoming wholly invested in a financially troubled company with which he had a relationship. The investments allegedly benefitted Rooney, while providing the fund with a “concentrated, undiversified and illiquid position in a cash poor company with a lengthy track record of losses.”

Finally, in SEC v. Kapur, No. 11-CV-08094 (S.D.N.Y. 2011), the SEC charged Kapur, a hedge fund manager and managing director, with fraud in connection with repeated misrepresentations regarding the fund’s record, size and credentials. Specifically, the SEC alleged that Kapur overstated performance, inflated assets and exaggerated the performance history and experience of the fund’s management team, which allowed the firm to appear as if it had been outperforming the market.

There is no reason to believe that the SEC’s Division of Enforcement and, specifically, the Asset Management Unit plan to limit this new analytics-based approach to the world of hedge funds. Indeed, the SEC’s Asset Management Unit has expressly stated that the new approach is being applied “across the investment adviser space.” Given the resources committed to the Asset Management Unit, both hedge funds and investment advisers should expect to see an increase in the number of investigations and enforcement actions.

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