Compliance failures cost hedge fund advisor $5 million

Compliance gets no respect. Until that is, one of the regulatory alphabet catches wind of an oversight and slaps firms in the financial services sector with hefty fines. Only then, do some management teams turn to their compliance team…but often only to give ‘em the “fish eye!”

What if financial services firms put compliance first?

What would that save them? Lots, especially given how affordable so many compliance solutions are in the grand scheme of exposure, fines, and penalties.

Here’s a prime example. Early this month, the Securities and Exchange Commission (SEC) hit a private fund manager in the mortgage-backed securities space with a $5 million penalty to settle charges stemming from compliance deficiencies that contributed to the firm’s failure to ensure that certain securities in its flagship fund were valued properly. The fund manager’s chief investment officer (CIO) was also penalized, agreeing to pay a $250,000 penalty.

Can well-regarded, top-rated funds still fail compliance tests?

Yes, they can. In the case of Deer Park Road Management Company LP and its flagship STS Partners’ fund which has been ranked one of the most consistent-performing hedge funds in the US, SEC investigators found that Colorado-based investment adviser failed to have policies and procedures to address the risk that its traders were undervaluing securities and selling for a profit when needed.

According to Daniel Michael, Chief of the SEC’s Enforcement Division’s Complex Financial Instruments Unit, the firm also failed to guard against its traders’ providing inaccurate information to a pricing vendor and then using the prices it got back to value bonds. CIO Scott Burg oversaw the valuation of certain assets in the flagship fund and approved valuations that the traders flagged as “undervalued” with notations to “markup gradually.”

Also overseeing valuation was a committee comprised of the principal’s relatives and others without relevant expertise.

“Valuation of client assets is a critically important area for investment advisers,” Michael noted. “Deer Park’s pervasive compliance failures allowed its traders to mark assets up gradually instead of marking them to market, in violation of the accounting principles they were required to follow.”

Deer Park consented to a censure and both the fund and its CIO agreed to act compliantly going forward.

Was a lack of oversight worth $5 million to the firm/ $250K to the CIO?

Not in hindsight. One cannot stop bad actors from acting badly, but a well-run compliance system can spot irregularities and give an attentive compliance team a chance to nip exposures before they get out of hand. That’s where Patrina can help. We’ve built our business based on helping organizations keep track of “bad apples,” and stay on the “straight and narrow” efficiently and cost-effectively. So, let’s talk. Call 212-233-1155 to ask about Patrina’s cost-effective, designated third-party services, our comprehensive 8-module compliance solution, and compliant data capture & file storage, and records archiving specifically designed for the financial services community. Be smart. Be covered. Let’s talk. I have passed that on to the team who will be back in the half motion this evening