SEC Charges Hedge Fund Adviser with Engaging in Prohibited Principal Transactions and Retaliating Against Whistleblower

by Dechert LLP

The U.S. Securities and Exchange Commission (SEC or Commission) issued a cease and desist order on June 16, 2014 (the Order) against Paradigm Capital Management, Inc. (Paradigm) and its founder, Director, President and Chief Investment Officer, Candace King Weir (Weir).The Order alleged that Weir caused Paradigm’s hedge fund client, PCM Partners L.P. II (Fund), to engage in certain transactions (Transactions) with a proprietary account (Trading Account) at the Fund’s prime broker, C.L. King & Associates, Inc. (C.L. King). Paradigm and C.L. King were allegedly under the common control of Weir. The Order further alleged that, because of Weir’s personal interest in the Transactions and the fact that the committee designated to review and approve the Transactions on behalf of the Fund was conflicted, Paradigm failed to provide the Fund with effective disclosure and failed effectively to obtain the Fund’s consent to the Transactions, as required under the Investment Advisers Act of 1940 (Advisers Act).

In addition, the Order alleged that Paradigm retaliated against a whistleblower who had notified the SEC of the Transactions. According to the SEC, the Order represents the first case filed under the Commission’s new authority to bring enforcement actions against those that retaliate against whistleblowers.2

The Order directed Paradigm and Weir to, among other things, disgorge to certain Fund investors $1,700,000, which represented the approximate amount of administrative fees the Fund paid in connection with the Transactions.3 The Order also directed Paradigm and Weir to pay a $300,000 civil penalty and prejudgment interest.

The Transactions and Alleged Violations of Advisers Act Section 206(3)

Background. According to the Order, Weir owned 73% of Paradigm and had ultimate control of, and decision-making authority for, Paradigm. Further, Weir owned 99% of the entity serving as the Fund’s general partner and approximately 73% of C.L. King.

The Order alleged that, from at least 2009 through 2011, Weir caused the Fund to engage in a trading strategy designed to reduce Fund investors’ tax liability. In part, the strategy involved selling to the Trading Account certain securities that had unrealized losses. The sales were made at prevailing market prices, and the resulting realized trading losses were allegedly used to offset the Fund’s realized gains. The Transactions were executed using C.L. King’s trading systems, and C.L. King did not charge a markup or commission on the Transactions. In some instances, Weir caused the Fund to later repurchase certain of the securities initially sold to the Trading Account.

Section 206(3) of the Advisers Act makes it unlawful for an investment adviser, directly or indirectly, “[a]cting as principal for his own account, knowingly to sell any security to or purchase any security from a client … without disclosing to such client in writing before the completion of the transaction the capacity in which he is acting and obtaining the consent of the client to such transaction.” Because Weir controlled both Paradigm and C.L. King, the Transactions involved an investment adviser, for its own account,4 knowingly purchasing securities from, and (in some instances) selling securities to, a client. Recognizing this issue, Paradigm established a conflicts committee to review and approve each Transaction on behalf of the Fund. However, as described below, the makeup of the committee allegedly resulted in insufficient disclosure and consent for purposes of Section 206(3).

“Conflicted” Conflicts Committee. The Order alleged that, because Weir owned and controlled the Fund’s general partner and shared in the trading profits and losses resulting from the Transactions through her ownership in C.L. King, disclosure directly to Weir would be insufficient and she could not provide effective consent to the Transactions on behalf of the Fund.

According to the Order, the conflicts committee established to review each Transaction on behalf of the Fund consisted of Paradigm’s Chief Compliance Officer, who reported directly to Paradigm’s board of directors (including Weir), and Paradigm’s Chief Financial Officer (CFO), who reported directly to Weir. The CFO also served as C.L. King’s chief financial officer. The Order alleged that the CFO was in a “conflict situation” – and thus, the conflicts committee was itself conflicted – because during the CFO’s evaluation of each Transaction, he was also monitoring the Transaction’s impact on C.L. King’s net capital, in his capacity as C.L. King’s chief financial officer.5

Because both Weir and the conflicts committee were allegedly conflicted, disclosure of the Transactions to either Weir (as a controlling person of the Fund’s general partner) or the conflicts committee was allegedly insufficient for purposes of Section 206(3). Similarly, because of these conflicts, neither Weir nor the conflicts committee allegedly could provide consent on behalf of the Fund that was adequate for purposes of Section 206(3). As a result, according to the SEC, the Transactions were effected without sufficient consent or disclosure and, thus, violated Section 206(3).6

Whistleblower Retaliation

In March 2012, Paradigm’s then-head trader (Whistleblower) voluntarily notified the SEC of the Transactions. Four months later, the Whistleblower notified Weir and another C.L. King officer that he had reported potential securities law violations to the SEC. Shortly thereafter, according to the Order, Paradigm embarked on a series of adverse employment actions against the Whistleblower that ultimately resulted in the Whistleblower resigning from Paradigm.

Section 21F(h) of the Securities Exchange Act of 1934 (Exchange Act) states that an employer may not “discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate against, a whistleblower in the terms and conditions of employment because of any lawful act done by the whistleblower … [i]n providing information to the Commission in accordance with this section."7

Upon learning that the Whistleblower had provided information to the SEC regarding the Transactions, Paradigm allegedly removed the Whistleblower from the trading desk and relieved him of his day-to-day trading and supervisory responsibilities. Paradigm also moved the Whistleblower to a different office building and instructed him to prepare a report concerning his disclosures to the Commission. The Whistleblower was later assigned to identify potential wrongdoing at the firm and, because Paradigm determined not to provide the Whistleblower with electronic access to its trading system, was given hard copies of more than 1900 pages of trading data to review in connection with the assignment. The Whistleblower was also tasked with consolidating multiple trading procedure manuals and proposing revisions to Paradigm’s trading policies and procedures. These and other actions detailed in the Order allegedly constituted adverse employment actions in violation of Exchange Act Section 21F(h).

Considerations for Advisers after Paradigm

In light of this case, investment advisers that engage in principal trades may benefit from reviewing their policies and procedures for compliance with Advisers Act Section 206(3). To the extent any form of board or committee is used as a mechanism of providing disclosure to, or obtaining consent from, clients for principal trades, advisers may wish to consider the composition of such board or committee. In particular, advisers should consider whether the composition of such board or committee is sufficiently independent from the adviser (or its affiliates) to provide the necessary check on self-dealing that Section 206(3)’s requirements are intended to achieve. Investment advisers should also understand that, in Paradigm, the Transactions were apparently undertaken for the benefit of Fund investors (at prevailing market prices) and that the Transactions and the conflicts committee were disclosed. Notwithstanding the apparent lack of intent to defraud Fund investors, the composition of the conflicts committee nonetheless resulted in alleged violations of Section 206(3).

Investment advisers may also benefit from reviewing their policies and procedures concerning whistleblowers. Among other things, such policies and procedures should seek to ensure that the adviser’s response to and management of a whistleblower situation is in accordance with all legal requirements and should sufficiently address the competing concerns and risks presented when a whistleblower has provided information to the Commission.







According to the SEC, Paradigm charged the Fund an administrative fee for, among other things, compliance-related expenses, including expenses associated with the conflicts committee’s review of the Transactions.


The SEC Staff has stated that an investment adviser’s ownership of a significant interest (e.g., more than 25%) in a pooled investment vehicle may cause cross transactions involving such a pooled investment vehicle to be treated as principal transactions under Section 206(3). Whether such a transaction implicates Section 206(3) depends on the facts and circumstances of the transaction, including the extent of the ownership interest of the adviser and/or its controlling persons or other personnel of the adviser. See Gardner Russo & Gardner, SEC Staff No-Action Letter (pub. avail. June 7, 2006) at n.9 (“The Commission has deemed ownership interests of controlling persons of an investment adviser to be ownership interests of the adviser for purposes of Section 206(3) of the Advisers Act.”)


The Order did not address whether Paradigm’s Chief Compliance Officer, who reported directly to Paradigm’s board of directors (including Weir), was also in a “conflict situation.”


Paradigm’s Form ADV Part 2A (Brochure) described the conflicts committee’s role in reviewing and approving the Transactions on behalf of the Fund. However, the Paradigm Brochure failed to disclose that the CFO, as a member of the conflicts committee, also served as C.L. King’s chief financial officer and was responsible for monitoring the Transactions’ impact on C.L. King’s net capital. As a result of this omission, according to the SEC, the Brochure’s disclosure concerning the conflicts committee was deemed materially misleading.


The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) established a whistleblower program that requires the Commission to pay an award to eligible whistleblowers who voluntarily provide the Commission with original information about a violation of the federal securities laws that leads to successful enforcement. For purposes of this provision, a “whistleblower” is “any individual who provides … information relating to a violation of the securities laws to the Commission, in a manner established, by rule or regulation, by the Commission.” Exchange Act Section 21F(a)(6).


Written by:

Dechert LLP

Dechert LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.