Faking Your Returns

Some Securities and Exchange Commission enforcement actions catch my attention in looking for lessons on what not to do. The SEC recently charged a Boston-based father-son duo of fund managers and their firms with securities fraud for misleading investors about their investment strategy and past performance. This case caught my attention because it came out of Boston and the father is a professor at MIT. The respondents have consented to the SEC’s administrative order, but neither admit nor deny the findings in the order. For the discussion below, I’m assuming the findings are true so we can learn some lessons on what fund managers should not do.

Gabriel Bitran founded GMB Capital Management LLC in 2005 for the stated purpose of managing hedge funds using quantitative models he developed based on his academic optimal pricing research. Gabriel and his son Marco Bitran solicited potential investors with three selling points that ultimately ended up not being true:

(1) very successful performance track records purportedly based on actual trades using real money from 1998 to the inception of the hedge funds;
(2) the firm’s use of Gabriel’s proprietary optimal pricing model to trade ETFs; and
(3) Gabriel’s pedigree and his involvement as the founder and portfolio manager of the hedge funds.

They managed to raising over $500 million for eight funds and various managed accounts. But in the process made misrepresentations to investors and made at least two disastrous investment decision.

First, they told potential investors that the pre-inception performance track records since 1998 were based on actual trades using real money. That was not true. Their track record was based on back-tested hypothetical simulations. It was a great performance, showing an average annual return of over twenty percent without a single calendar year of investment losses since 1998.

Second, they solicited investors to two funds by promising that GMB would use Gabriel’s optimal pricing models to trade liquid securities such as ETF.  But those funds were actually invested almost entirely in other hedge funds and funds of funds.

Third, in May 2008, Gabriel and Marco divided GMB’s business. Marco started advising the hedge funds under a new entity, GMB Capital Partners LLC, and Gabriel managed the other clients through GMB Management. Although Gabriel had no involvement in the GMB Partners’ hedge funds, GMB Partners and they continued to tell potential investors that they were managed by Gabriel.

When the SEC’s Boston Regional Office examined GMB Management and they provided a document that supposedly was a contemporaneous record of Gabriel’s trades since 1998. They provided this document in response to the exam staff’s request for books and records that supported GMB Management’s claims in its marketing material of a successful track record since 1998. In fact, the document was not true or accurate and was created solely for the purpose of responding to the staff’s books and records request.

Using hypothetical backtested performance is not inherently false and misleading, but it is highly suspect. It’s all too easy to continually tweak the formulas as market conditions evolve in the present day to meet your needs.

It turns out that one of GMB’s funds has a significant interest in funds that had invested in the Petters Group Worldwide and Bernard L. Madoff Investment Securities LLC.

The Bitrans released this statement:

“The Bitrans invested the vast majority of their (and their family’s) net worth in the GMB funds, alongside other investors, and had great confidence in GMB’s quantitative models. To be sure, 2008 was a difficult year for the markets and for the investment industry as a whole. That aside, the majority of GMB’s funds and managed accounts either made money for investors, or significantly outperformed the S&P 500 over their operating lifetime. This strong relative performance was delivered during one of the most challenging market environments of the last several decades. The Bitrans are pleased to have reached a settlement with the SEC, on these issues which date back several years, and to put this matter behind them.”

Gabriel Bitran’s optimal pricing model is the basis for airline prices and their constant fluctuations. Bitran’s models estimate optimal pricing by assessing the factors that create demand and make supply available in the marketplace. The parallel in the financial markets is willingness to pay. Bitran’s models focuses on the value market participants place on securities at different points in time. Based on this data, they theoretically can anticipate capital flows into various markets and instruments.

This is another one of the cases that makes me scratch my head and wonder how a smart, reasonable person could make such mistakes. Clearly, the full background and key facts are missing from the news stories and SEC order. Some could be simple footfaults or a failure to under stand regulatory requirements. A few of the statements indicate more overt action that seems wrong. Given that the Bitrans are likely subject to other claims, it’s unlikely we will ever learn what lead them down the dark corridors of fraud and deceit.


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