Manager Learns $170M Lesson: Replacing Successful Traders With Algorithms May Result in Significant Penalties Unless Properly Disclosed

Management of parallel funds that follow similar strategies can be a minefield for an adviser. One fund manager learned that lesson the hard way and has settled with the SEC for $170 million in disgorgements, interest and penalties on charges that it transferred top-performing traders from its flagship fund to a proprietary fund and replaced them with what the SEC claimed was a “replication algorithm” that underperformed the live traders. The SEC’s charges rested on the manager’s alleged failure to make adequate disclosures about material matters, including the existence of the proprietary fund, the manager’s transfer of traders and its use of the algorithm. The action is notable because the manager was accused not of cherry picking profitable trades but, rather, the traders themselves. This article details the facts giving rise to the enforcement action; the manager’s alleged disclosure and compliance failures; and the terms of the settlement. See our two-part series on avoiding parallel fund conflicts: “New SBAI Standards and Case Study Provide Guidance for Mitigating Conflicts” (Jun. 11, 2020); and “Common Challenges for Hedge Fund and Credit Strategies” (Jun. 18, 2020).

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