The Blotter: Falcone, Harbinger settle with SEC for $18 million

August 23, 2013 08:27 AM
Also: Chariot Advisors hit for claiming algorithmic trading ability

This week’s regulatory actions: 

NORTH CAROLINA

CFTC files action to revoke registration of Prestige Capital Advisors 

The U.S. Commodity Futures Trading Commission (CFTC) filed a notice of intent  to revoke the registration of Prestige Capital Advisors, LLC  of Charlotte, NC, as a commodity trading advisor (CTA). 

The CFTC alleges that Prestige is subject to statutory disqualification from CFTC registration based on an order of default judgment and permanent injunction entered against Prestige in the U.S. District Court for the Western District of North Carolina on Jan. 25, 2013. The order finds that Prestige fraudulently solicited and accepted more than $4.7 million from multiple pool participants for investment in one or more commodity pools that traded among other things, commodities and futures contracts. The order also finds that Prestige misappropriated pool participant funds, posted false trading returns on a website called BarclayHedge (where fund managers could post unverified historical returns for prospective clients to view), sent false trading results to at least one Prestige pool participant, and issued false account statements.  As a result, Prestige was ordered to pay approximately $6.9 million in civil monetary penalties and restitution of over $4.1 million. 

FLORIDA

Federal court enters $2.2 million default judgment order against Global Precious Metals Trading Company for operating a fraudulent off-exchange precious metals scheme

The CFTC obtained a federal court default judgment order against Global Precious Metals Trading Company, LLC (GPMT) of Coral Gables, Fla., and its principal Michael Ghaemi of Miami, Fla., charged with running a fraudulent precious metals scheme and misappropriating customers’ funds. 

The order, entered by Federal District Judge Ursula Ungaro, requires GPMT and Ghaemi to pay a $1.26 million civil monetary penalty, $736,979 in restitution, and to disgorge $186,860 in ill-gotten gains.The order also imposes permanent trading and registration bans against them and prohibits them from violating the Commodity Exchange Act (CEA) and CFTC regulations, as charged.

 The order finds that, from at least July 16, 2011 to August 2012, GPMT and Ghaemi illegally solicited and accepted approximately $800,000 from nine U.S. retail customers to purchase physical precious metals, such as gold, silver, platinum, and palladium, on a financed basis, and defrauded the customers in connection with the precious metals transactions. 

The order also finds that GPMT and Ghaemi defrauded their retail customers by claiming to sell actual physical metals, making loans to customers to purchase those physical metals, and arranging for storage of the physical precious metals, when, in fact, they did not purchase or store precious metals, even as they charged customers interest on their loans and storage fees.  

The order further finds that GPMT and Ghaemi misappropriated virtually all of their customers’ funds and lost virtually all of those funds to either personal or other unauthorized use of the funds or through speculative margin trading in an account at a London brokerage.  As a result, customers were left with no precious metals and with only a fraction of their funds having been returned to them. 

NEW YORK

CFTC seeks to revoke registration of Chicago Trading Managers 

The CFTC filed a notice of intent to revoke the registration of Chicago Trading Managers LLC (CT Managers).  CT Managers is currently registered with the CFTC as a commodity pool operator and commodity trading advisor.

The CFTC alleges that CT Managers is subject to statutory disqualification from CFTC registration based on a default judgment and permanent injunction order entered by the U.S. District Court for the Southern District of New York on May 15, 2013. That injunction prohibits CT Managers from committing further fraud.  Additionally, the default judgment includes findings that CT Managers defrauded pool participants who had invested more than $9 million by knowingly issuing or causing to be issued false account statements for the commodity pools.  

In the default judgment order, CT Managers was held liable for fraud and ordered to pay a civil monetary penalty of $1.4 million, jointly and severally with another defendant. 

COLORADO

CFTC seeks to revoke registrations of Veruus Wealth Management 

The CFTC filed a notice of intent to revoke the registrations of Veruus Wealth Management, LLC, a registered commodity pool operator and commodity trading advisor.  

The CFTC alleges that Veruus is subject to a statutory disqualification from CFTC registration based on an order of default judgment entered by the District Court for the City and County of Denver, Co. on Nov. 28, 2012.  In that private litigation, the plaintiffs alleged that the defendants solicited them to invest in a Veruus-managed foreign exchange trading account and that they were the victim of civil theft and conversion.  The judgment order entered by the Court found Veruus liable for civil theft and conversion of $339,517.79 in customer funds. 

NORTH CAROLINA

SEC charges Chariot Advisors for misleading fund board on algorithmic trading ability

The Securities and Exchange Commission (SEC) announced charges against a North Carolina-based investment adviser and its former owner for misleading an investment fund’s board of directors about the firm’s ability to conduct algorithmic currency trading so they would approve the firm’s contract to manage the fund.

The SEC alleges that Chariot Advisors LLC and Elliott L. Shifman misled the fund’s board about the nature, extent, and quality of services that the firm could provide as he touted the competitive benefits of algorithmic trading in two presentations before the board. Contrary to what Shifman told the directors, Chariot Advisors did not devise or otherwise possess any algorithms capable of engaging in the currency trading that Shifman was describing.  After the fund was launched, Chariot Advisors did not use an algorithm model to perform the fund’s currency trading as represented to the board, but instead hired an individual trader who was allowed to use discretion on trade selection and execution.  The misconduct by Shifman and Chariot Advisors caused misrepresentations and omissions in the Chariot fund’s registration statement and prospectus filed with the SEC and viewed by investors.

The case arises out of an initiative by the SEC Enforcement Division’s Asset Management Unit to focus on the “15(c) process” – a reference to Section 15(c) of the Investment Company Act of 1940 that requires a registered fund’s board to annually evaluate the fund’s advisory agreements.  Advisers must provide the board with the truthful information necessary to make that evaluation.  Other enforcement actions taken against misconduct in the investment contract renewal process and fee arrangements include cases against Morgan Stanley Investment Management, a sub-adviser to the Malaysia Fund, and two mutual fund trusts affiliated with the Northern Lights Variable Trust fund complex.

“It is critical that investment advisers provide truthful information to the directors of the registered funds they advise,” said Julie M. Riewe, co-chief of SEC Enforcement Division’s Asset Management Unit.  “Both boards and advisers have fiduciary duties that must be fulfilled to ensure that a fund’s investors are not harmed.”

According to the SEC’s order instituting administrative proceedings, the false claims by Chariot and Shifman defrauded the Chariot Absolute Return Currency Portfolio, a fund that was formerly within the Northern Lights Variable Trust fund complex.  In December 2008 and again in May 2009, Shifman misrepresented to the Chariot fund’s board that his firm would implement the fund’s investment strategy by using a portion of the fund’s assets to engage in algorithmic currency trading.  Chariot fund’s initial investment objective was to achieve absolute positive returns in all market cycles by investing approximately 80% of the fund’s assets under management in short-term fixed income securities, and using the remaining 20% of the assets under management to engage in algorithmic currency trading.

According to the SEC’s order, Chariot Advisors did not have an algorithm capable of conducting such currency trading.  The ability to conduct currency trading was particularly significant for the Chariot fund’s performance, because in the absence of an operating history the directors focused instead on Chariot Advisors’ reliance on models when the board evaluated the advisory contract.  Even though Shifman believed that the fund’s currency trading needed to achieve a 25 to 30 percent return to succeed, Shifman never disclosed to the board that Chariot Advisors had no algorithm or model capable of achieving such a return. 

According to the SEC,  because Chariot Advisors possessed no algorithm, currency trading for the fund was under the control of an individual trader who was not using an algorithm for at least the first two months after the fund’s launch.  Shifman had interviewed the trader prior to her hiring and knew that she used a technical analysis, rules-based approach for trading that combined market indicators with her own intuition.  The trader traded currencies for the fund until Sept. 30, 2009 when she was terminated due to poor trading performance. Subsequently, Chariot employed a third party who utilized an algorithm to conduct currency trading on behalf of the Chariot fund.

The SEC’s order alleges that the misconduct by Chariot and Shifman, who lives in the Raleigh area, resulted in violations of Sections 15(c) and 34(b) of the Investment Company Act of 1940 and Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8.  A hearing will be scheduled before an administrative law judge to determine whether the allegations contained in the order are true and whether any remedial sanctions are appropriate. 

NEW YORK

Philip A. Falcone and Harbinger Capital Partners agree to SEC settlement

 The SEC announced that New York-based hedge fund adviser Philip A. Falcone and his advisory firm Harbinger Capital Partners have agreed to a settlement in which they must pay more than $18 million and admit wrongdoing.  Falcone also agreed to be barred from the securities industry for at least five years.

The SEC filed enforcement actions in June 2012 alleging that Falcone improperly used $113 million in fund assets to pay his personal taxes, secretly favored certain customer redemption requests at the expense of other investors, and conducted an improper “short squeeze” in bonds issued by a Canadian manufacturing company. In the settlement papers filed in court today, Falcone and Harbinger admit to multiple acts of misconduct that harmed investors and interfered with the normal functioning of the securities markets. 

“Falcone and Harbinger engaged in serious misconduct that harmed investors, and their admissions leave no doubt that they violated the federal securities laws,” said Andrew Ceresney, Co-Director of the SEC’s Division of Enforcement.  “Falcone must now pay a heavy price for his misconduct by surrendering millions of dollars and being barred from the hedge fund industry.”

The settlement, which must be approved by the U.S. District Court for the Southern District of New York, requires Falcone to pay $6,507,574 in disgorgement, $1,013,140 in prejudgment interest, and a $4 million penalty.  The Harbinger entities are required to pay a $6.5 million penalty.  Falcone has consented to the entry of a judgment barring him from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization with a right to reapply after five years.  The bar will allow him to assist with the liquidation of his hedge funds under the supervision of an independent monitor.

Among the set of facts that Falcone and Harbinger admitted to in settlement papers filed with the court:

  • Falcone improperly borrowed $113.2 million from the Harbinger Capital Partners Special Situations Fund (SSF) at an interest rate less than SSF was paying to borrow money, to pay his personal tax obligation, at a time when Falcone had barred other SSF investors from making redemptions, and did not disclose the loan to investors for approximately five months.
  • Falcone and Harbinger granted favorable redemption and liquidity terms to certain large investors in HCP Fund I, and did not disclose certain of these arrangements to the fund’s board of directors and the other fund investors.
  • During the summer of 2006, Falcone heard rumors that a financial services firm was shorting the bonds of the Canadian manufacturer, and encouraging its customers to do the same.
  • In September and October 2006, Falcone retaliated against the financial services firm for shorting the bonds by causing the Harbinger funds to purchase all of the remaining outstanding bonds in the open market.
  • Falcone and the other defendants then demanded that the financial services firm settle its outstanding transactions in the bonds and deliver the bonds that it owed.  Defendants did not disclose at the time that it would be virtually impossible for the financial services firm to acquire any bonds to deliver, as nearly the entire supply was locked up in the Harbinger funds’ custodial account and the Harbinger funds were not offering them for sale.
  • Due to Falcone’s and the other defendants’ improper interference with the normal interplay of supply and demand in the bonds, the bonds more than doubled in price during this period.
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About the Author

In her many years covering the futures industry Ginger has interviewed some of today's best global hedge fund and commodity trading advisors. Ginger received a master's degree in journalism at Northwestern University's Medill School of Journalism and a bachelor’s in communication arts from the University of Wisconsin – Madison