Broker/Dealer Fraud and Mismanagement FINRA Arbitration and Litigation Attorney, Russell L. Forkey, Esq.
SEC Charges Scotland-Based Firm For Improperly Boosting Hedge Fund Client at Expense of U.S. Fund Investors
The Securities and Exchange Commission today charged a Scotland-based fund management group for fraudulently using one of its U.S. fund clients to rescue another client, a China-focused hedge fund struggling in the midst of the global financial crisis.
Martin Currie agreed to pay a total of nearly $14 million to the SEC and the United Kingdom’s Financial Services Authority (FSA) to settle the charges that it steered a U.S. publicly-traded fund called The China Fund Inc. into an investment to bolster the hedge fund. The hedge fund had acquired a significant and largely illiquid exposure to a single Chinese company. Martin Currie directly alleviated the hedge fund’s liquidity problems by deciding to use the China Fund – to the detriment of the fund and its shareholders – in a bond transaction that reduced the hedge fund’s exposure.
According to the SEC’s order instituting settled administrative proceedings against Martin Currie, the firm managed the China Fund side-by-side with the hedge fund through its SEC-registered investment adviser subsidiaries. These funds and other Martin Currie accounts made similar investments in Chinese companies under the direction of two senior portfolio managers based in Shanghai. One company was Jackin International, a printer-cartridge recycling company listed on the Hong Kong Stock Exchange.
According to the SEC’s order, in June 2007, Martin Currie’s lead portfolio manager in Shanghai caused the hedge fund to purchase $10 million of unlisted illiquid Jackin bonds that deviated from the fund’s normal equities-trading strategy. Martin Currie improperly classified those bonds as cash in its risk-management system, and as a result the liquidity and credit risks associated with the hedge fund’s exposure to Jackin weren’t revealed until November 2008 after the hedge fund had purchased additional Jackin bonds. By that time, the hedge fund’s total investment in Jackin had come close to breaching the fund’s limit on portfolio exposure to a single issuer.
The SEC’s order says that as the global financial crisis deepened, the hedge fund faced a significant increase in redemption requests by its investors, exacerbating the fund’s liquidity problems. At the same time, Jackin was starved for capital to continue funding its operations and make debt payments to bondholders such as the hedge fund. In response to the hedge fund’s overlapping problems, Martin Currie decided to use the China Fund to purchase $22.8 million in convertible bonds from a Jackin subsidiary. The subsidiary instantly lent $10 million of the proceeds to Jackin, which in turn redeemed $10 million in otherwise-illiquid bonds held by the troubled hedge fund. The bond transaction closed in April 2009.
According to the SEC’s order, Martin Currie officials were aware that the China Fund’s involvement presented a direct conflict of interest and may have been unlawful. In an attempt to cure that conflict, they sought and obtained approval from the China Fund’s board of directors. However, they failed to disclose that proceeds of the fund’s investment would be used to redeem bonds held by another client – the hedge fund. Martin Currie also failed to sufficiently consider whether the investment’s rationale and pricing were in the China Fund’s best interests.
The SEC’s order noted that the China Fund’s bond investment in the Jackin subsidiary turned out poorly. In April 2011, the China Fund sold the bonds for about 50 percent of their face value for a loss of $11.5 million.
The SEC’s order found that Martin Currie engaged in separate improper conduct by failing to follow the China Fund’s policies and procedures for fair valuing the convertible bonds at issue. Between April 2009 and October 2010, Martin Currie advised the China Fund’s board to value the convertible bonds at cost ($22.8 million) while failing to disclose information that was relevant for the board to fair value the bonds.
The SEC charged Martin Currie with certain violations of the antifraud, affiliated transaction, reporting, and compliance provisions of the Investment Advisers Act of 1940 and the Investment Company Act of 1940. Without admitting or denying the SEC’s findings, Martin Currie agreed to settle the SEC’s charges by paying a penalty of $8.3 million and accepting censures and cease-and-desist orders against future violations. Martin Currie also agreed to pay a penalty of £3.5 million ($5.6 million in U.S. dollars) to settle the FSA’s action. In reaching the settlement, the SEC took into account that Martin Currie had compensated the China Fund for losses and expenses arising from the misconduct. Martin Currie cooperated with the SEC’s investigation and implemented several remedial measures, including severing association with its lead Shanghai-based portfolio manager and making enhancements to its compliance program.