In a December 1, 2011 press release, the Asset Management Unit of the SEC’s Division of Enforcement (Division) announced the Aberrational Performance Inquiry (Inquiry), a new initiative to identify and combat hedge fund fraud. Under the Inquiry, the Division is using proprietary risk analytics to screen hedge funds’ performance returns to determine whether the stated returns are consistent with the fund’s investment strategy or appropriate benchmarks. If the Division identifies a hedge fund whose performance is aberrational – too high, too low or inconsistent with the fund’s strategy – the Division is likely to undertake additional quantitative and qualitative screens to determine the source of the aberration. Such screens may include contacting the fund’s manager directly, looking more closely at the sources of stated returns and examining factors other than returns. This article: discusses the Inquiry in greater depth; details the factual and legal allegations in the SEC’s administrative proceeding against unregistered investment adviser LeadDog Capital Markets LLC and its general partners – an action that was brought as part of the Inquiry; and identifies specific practices for hedge fund managers to consider in light of the Inquiry. For more on the Inquiry based on information that was publicly available as of April of this year, see “SEC’s Hedge Fund Focus to Include Review of Funds That Outperform the Market
,” Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).