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Regulators co-operate to counter fraud epidemic

By Sniffer

January, 06:- US and European regulators are intensifying their co-operation in investigating an epidemic of hedge fund and other major financial frauds.

The US Securities Exchange Commission has entered into over 30 formal information sharing arrangements with foreign counterparts. In May 2000, the SEC, together with the U.S. Commodity Futures Trading Commission (CFTC), signed a Memorandum of Understanding with the Monetary Authority of Singapore.

In the past year there have been a plethora of hedge fund frauds, with the major ones totalling around $2.5 billion (see table). They range from Refco, Bayou and Wood River in the US to Phoenix in Germany. Bankers, fund managers and regulators remark that the extent of the fraudsters’ greed has been mind boggling. They involve rigged performance figures, claims of profits instead of large losses, false auditors or lax auditing and controls and theft (see table below of the largest frauds).

In court documents and memoranda supplied by the liquidator of a failed hedge fund company, Philadelphia Alternative Asset Management (PAAM), the alleged fraud has similarities to the fraudulent techniques of Nick Leeson who brought down Barings Bank ten years ago. The CFTC and Liquidator are investigating PAAM manager Paul Eustace’s relationship with Thomas Gilmartin, a New York-based senior vice-president at Man Financial, which is acquiring parts of Refco’s derivative unit, including the Singapore branch. The alleged PAAM fraud relates to losses of $175 million hidden in an account that was not disclosed to investors. Profits were allegedly disclosed in one account, while losses were transferred to another account without the knowledge of investors. Man Financial has placed Gilmartin, who is allegedly a stakeholder of the hedge fund, on administrative leave. It is conducting its own investigation in co-operation with the CFTC.

In evidence to the UK Commons Treasury Select Committee, last week, Sir Callum McCarthy, chairman of the UK Financial Services Authority (FSA), the British regulator, said that hedge fund managers and investment banks faced a "pincer movement" from British and US regulators if they fail to improve the way they manage their affairs and dealing.

In a recent speech in London, SEC Commissioner Roel C. Campos emphasized that he was concerned about the "complex new products, intricate trading strategies and inventive capital raising techniques, not to mention a freer flow of fraud." The task at hand for US, European and other international regulators "is to co-operate and develop "high quality and consistent regulatory requirements to govern our markets and address the inherent risks", he said.

"A subset of investor confidence in the marketplace is investor confidence in the regulatory regime, " said Mr Campos, adding that he was concerned about "a constantly morphing, opaque… trillion dollar (hedge fund) industry".

In a recent speech in Switzerland, Sharon Brown-Hruska, Commissioner US Commodity Futures Trading Commission said that international regulators intended to enhance transparency and the clarity of regulatory requirements. In this way market professionals and end-users located outside a national jurisdiction will be able to understand the types of conduct that may require registration, licensing or authorisation.

Large Frauds and Suits in the Courts this year

Refco - US$440 million loans allegedly hidden from Refco’s prospectus of the stock exchange listing, August 2005. Former Refco chief executive Phillip Bennett indicted on securities fraud, conspiracy, false filings with the SEC and wire fraud. Bennett denies allegations.
Phoenix Kapitaldienst - German prosecutors disclosed that they are probing allegations that the fund falsified the existence of around 700 million euros (US$826m) BaFin, the German financial regulator is investigating Phoenix for fraud and breach of fiduciary duty.
Bayou Management - Up to US $440 million fraud. Samuel Israel III and Daniel Marino, directors of the fund pleaded guilty to conspiracy, investment adviser fraud and mail fraud. The men admitted that they told investors that the funds were gaining in value when they were incurring large losses.
Wood River Capital - SEC accuses US $265 million Wood River hedge fund and John Whittier, its founder, of fraud and failure to have the fund audited. Most of the fund’s assets were invested in Endwave, a U.S. share that collapsed.
MDL Capital Management - Ohio's Attorney General filed a lawsuit against MDL a hedge fund manager. The case relates to the recovery of a US$215 million loss incurred in managing funds of the Ohio Bureau of Workers' pension fund. The lawsuit charges the defendants with common law fraud, violations of the Ohio Securities Act, negligent misrepresentation, breach of fiduciary duty, breach of contract, conspiracy and unjust enrichment.
Philadelphia Alternative Asset Management - Alleged fraud relating to losses of $175 million hidden in an account that was not disclosed to investors. Regulators are investigating hedge fund manager Paul Eustace’s relationship with Thomas Gilmartin, a New York-based senior vice-president at Man Financial. Profits were allegedly disclosed in one account, without disclosing huge losses in another.
KL Funds - SEC announces action to halt fraud of around $80 million by a group of Palm Beach, Florida-based hedge funds, its principals, investment advisers and affiliated registered broker-dealer. The SEC alleges that beginning as early as 1999 and through February 2005, the hedge fund had raised $81 million for at least 250 investors. They used phoney account statements and sent false account statements to investors.
Groundswell Partners - SEC takes action against Massachusetts hedge fund Groundswell Partners and its founder Mark R. Conway. Fund claimed assets of $43 million when they were $14 million. The SEC alleges that Conway defrauded his clients by not disclosing millions of dollars in losses incurred by Groundswell. The complaint alleges that Conway altered documents to inflate the performance and assets. In a tape recording, Conway disclosed that the fraud took place from around the beginning of 2001 to the end of October 2005.

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