U-Turn Valuations, Insider Trading Yield Adviser SEC Sanctions

by Dorsey & Whitney LLP

The valuation of assets held by advisers has been a key issue for the Commission. Likewise, insider trading on political intelligence is also a focus of SEC Enforcement. The Commission’s latest case involving an adviser involves each of these key areas and culminates with the adviser withdrawing its registration. In the Matter of Visium Asset Management, L.P., Adm. Proc. File No. 3-18473 (May 8, 2018).

Visium was a registered investment adviser with more than $7.8 billion of assets under management. Two related investment vehicles were involved here: Visium Credit Master Fund, LT. – the Credit Fund – and Visium Balanced Master Fund Ltd. – the Balanced Fund. Credit Fund Series A investors paid a 1.5% management fee and a 1.5% performance fee. Series B investors paid a 2% management fee and a 20% performance fee based on a high-water mark and the fund’s NAV.

In May 2009 the adviser launched the Credit Fund. It focused on higher risk investments such as thinly traded corporate debt instruments issued by healthcare companies. Those bonds and loans were not listed on an exchange. They did trade over the counter where market makers provided price quotes.

From July 2011 to December 2012 portfolio managers Christopher Plaford and Stefan Lumiere engaged in a mismarking scheme to falsely value certain securities held by the Credit Fund and improperly inflate the NAV and apparent performance. Sham price quotes were used to override those which should have been used by Credit fund’s independent administrator.

The sham quotes were obtained by the two portfolio managers from at least three outside brokers, each of whom was at a different firm. The two men made the sham quotes appear legitimate by asking the brokers involved in the practice for specific prices they wanted in an email or instant message sent back to them. The brokers would then send back what were called U-turn quotes.

During the eighteen months this practice was used, the Credit Fund had, on average, about 72 bond or loan positions at month-end. The U-turn prices were used for anywhere from 6 to 28 positions. Virtually all of the U-turn prices resulted in higher valuations for long positions or lower valuations for short positions held by the Credit Fund. The scheme caused the Credit Fund to routinely overstate its month-end NAV by amounts which ranged from 2.4% to 7.2%. As a result of this practice investors purchased and sold interests at incorrect prices. It also resulted in the Credit Fund over paying its performance fees by $2,622,709 and its management by $544,700.

The improper valuations also resulted in deceptive disclosure to investors. FASB Accounting Standards Codification Topic 820 regarding fair value has a three tier framework for measuring fair value based on the quality of the inputs used. Since Mr. Platford used the sham quotes to keep the values at Level 2 for those where quotes were not available but fair value could be determined, it was incorrect. The scheme also resulted in misstatements about the performance of the Fund, the limited partner’s total capital, net investment income and monthly and yearly returns as well as Visium’s firm-wide assets under management. Likewise, the scheme was contrary to the disclosed valuation methods and the firm’s policies and procedures.

The two portfolio managers also engaged in an insider trading scheme. Initially, between 2005 and 2011 there was considerable speculation as to whether the Office of Generic Drugs or OGD at the Federal Food and Drug Administration would approve pending enoxaparin applications or Abbrevited New Drug Applications. During the period Gordon Johnston, a former OGD official retained by Visium, furnished information that certain applications were moving to approval. As that information was transmitted regarding an application for Momenta Pharmaceuticals, Inc. the Balance Fund traded in advance of the announcement. Mr. Johnston continued to furnish information on the applications that was used to formulate the Balanced Fund’s trading before the announcement on an application by Watson Pharmaceuticals, Inc. This resulted in trading profits of $6,982,396.

The Balanced Fund and the Credit Fund also traded on inside information obtained by CMS in May 2012 from consultant David Blaszczak. Mr. Blaszczak, a former Centers for Medicare and Medicate Services or CMS employee, was convicted of illegal tipping in connection with another insider trading case centered on inside information he obtained from CMS in April, 2018. This resulted in trading profits of $284,939. While the firm had an insider trading policy it was not effectively implemented since inadequate steps were taken to monitor employee communications with consultants.

The Order alleges violations of Securities Act section 17(a), Exchange Act section 10(b), and Advisers Act sections 204A, 206(1), 206(2), 206(4), and 207. To resolve the proceedings Respondent undertook to return all investor funds no later than one year from the date of the Order and filed a Form ADV-W to withdraw its registration as an investment adviser. Respondent also consented to the entry of a cease and desist order based on the sections cited in the Order as well as a censure. The firm will pay disgorgement of $4,755,223 and prejudgment interest of $720,711. In addition, Respondent will pay a penalty equal to the amount of the disgorgement. See also In the Matter of Steven Ku, Adm. Proc. File No. 3-18474 (May 8, 2018)(proceeding against CFO for failure to supervise two portfolio managers re valuation; resolved with the suspension of Respondent from the securities business for a period of twelve months and the payment of a $100,000 civil penalty).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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