| SEC chairman Mary Schapiro; Photo: (Bloomberg) |
When Mary Schapiro took over as SEC chairman in January 2009, she put a sign on the door of her office: “How Does It Help Investors?” It reminds all who enter that Schapiro sees her mission clearly. The SEC must give investors confidence that the Commission is looking out for them—whether the agency is reviewing new products or trading practices or demanding transparency from public companies. Markets should be efficient and fair and everyone should fear the consequences of violating securities law. “Think two, three times before they step near the line,” Schapiro stressed in an interview soon after she took office.
On Monday Schapiro announced that she would leave office on Dec. 14. A few hours later the White House said that President Obama would designate SEC member Elisse Walter to succeed Schapiro as chairman.
As many observers see it, the Schapiro administration deployed a newfound—and welcome—toughness in its treatment of rogue players, many of them hedge funds. The agency brought in outside industry experts who did not necessarily have a legal background and encouraged them to expand the kinds of cases the agency brought. Along with traditional fraud and insider trading suits, the new legal action related to valuations, aberrational performance, trade allocations and other previously over-looked areas.
Since the beginning of 2010, the SEC has filed more than 100 cases involving hedge fund malfeasance such as misusing investor assets, lying about investment strategy or performance, charging excessive fees, or hiding conflicts of interest.
Experts say the focus on rogue players began with Schapiro’s appointment of Robert Khuzami as Enforcement Chief shortly after she took control of the agency, followed by her July 2009 appointment of George Canellos as the head of the New York region. The largest of the SEC’s regional offices, its responsibilities include the commonly investable activities of hedge funds.
Khuzami and Canellos had earlier served as federal prosecutors in the U.S. Attorney’s Office for the Southern District of New York and worked together on the securities and commodities fraud task force of the U.S. Attorney’s Office.
Under Khuzami and Schapiro’s leadership, the Enforcement Division created five national specialized units dedicated to investigating highly specialized and complex areas of securities law. This included The Asset Management Unit, which focused, among other areas, on hedge funds and private equity funds.
The unit was staffed with men and women, not necessarily lawyers, who had specialized knowledge of the alternative investment industry. “(The unit) was more focused and had more expertise,” says Barry Goldsmith, co-chair of Gibson Dunn’s Securities Enforcement Practice and former Chief Litigation Counsel at the SEC’s Enforcement Division. “They started to bring cases in areas different from what the Commission had previously been bringing.”
For example, in October the SEC charged New Jersey-based Yorkville Advisors LLC founder and president Mark Angelo and chief financial officer Edward Schinik with scheming to overvalue assets under management and exaggerate the reported returns of hedge funds they managed to hide losses and increase the fees collected from investors.
This was the seventh case arising from the SEC’s Aberrational Performance Inquiry, which uses risk analytics to identify hedge funds posting suspicious returns.
Throughout Schapiro’s tenure, the Enforcement Division has taken advantage of its new power to enter formal orders of investigation, complete with the power to issue subpoenas to even unregistered hedge funds.
The SEC recently brought cases against firms that made misrepresentations about whether the fund managers had “skin in the game” along with investors in their hedge fund. For example, in May 2012 the SEC charged a Miami-based hedge fund adviser with deceiving investors into believing its executives had personally invested in the $1 billion Quantek Opportunity Fund.
The SEC Enforcement Division and its Asset Management Unit also brought a case against a San Francisco-based hedge fund manager Hausmann-Alain Banet and his firm Lion Capital Management, alleging they stole more than a half-million dollars from a retired schoolteacher who thought she was investing her retirement savings in Banet’s hedge fund.
Though many of the government’s ever widening insider trading cases, including the high-profile prosecution of Galleon Group founder Raj Rajaratnam, have been led by the U.S. Justice Department, the SEC did a lot of the leg work to help prosecutors make their case.
As observers assess her career, Schapiro wins praise for reviving the agency after its lax oversight was seen as a contributing factor in the financial crisis. The SEC’s failure to detect the Bernard Madoff fraud was an especially humiliating moment for the agency, as many saw it. But Schapiro suffered her own setbacks, most recently failing to push through tougher rules for money-market funds.
As Walter takes the reins, the SEC is writing regulations that would permit certain hedge funds to advertise for the first time. Other potential hedge fund cases are no doubt under consideration. As the alternative investment crowd well knows, the cops are staying on the beat.
