Aberrational Performance Inquiry of Nabs Another Private Fund Manager

The SEC has once again claimed that its Aberrational Performance Inquiry has identified another miscreant. Once again, I’m skeptical that the SEC is actually using “proprietary risk analytics” to identify hedge funds with suspicious returns.

The SEC alleges that Yorkville Advisors overstated the value of the assets in its funds to improve marketability and increase fees. According to the SEC complaint, the failure was two-prongeed: one of misstatements and a second failure to follow the funds’ own policies and procedures on valuation. Yorkville denies the charges. Yorkville claims to have maintained “robust control procedures” to ensure that assets were valued properly, including having two former SEC enforcement lawyers as members of Yorkville’s valuation committee.

The lesson from the complaint is to follow your own policies and procedures when it comes to valuation and don’t hide information from your auditors.

According to the SEC press release, this is the seventh case arising from the “SEC’s Aberrational Performance Inquiry, an initiative by the Enforcement Division’s Asset Management Unit that uses proprietary risk analytics to identify hedge funds with suspicious returns.” I have seen four other cases, but I’m not sure I can identify the other two cases.

Robert Khuzami, the Director of the Division of Enforcement for the SEC revealed an investigative initiative concerning hedge funds during Congressional testimony in March, 2011.  The Aberrational Performance Inquiry program is now focusing on hedge funds that outperform “market indexes by 3% and [are] doing it on a steady basis.”  Khuzami referred to such performance as “aberrational,” and stated that Enforcement is “canvassing all hedge funds” for such “aberrational performance.

Yorkville disclosed that the SEC started looking at it in August, 2009. That’s almost two years before the Aberrational Performance Inquiry program was announced and only six months after Khuzami joined the SEC. That timing leaves me skeptical that the Aberrational Performance Inquiry program discovered the issues with Yorkville. In addition, Yorkville made investments in equities and debt so there is not a good index to benchmark the funds’ performance to determine if it is “aberrational.”

I have no doubt that the SEC is looking closer at the performance of private funds to see if the performance numbers make sense given the markets and a fund’s investment strategy. That is a direct result of the aberrations in Madoff’s performance.  And I have no doubt that there is group in the SEC looking at performance and worked on the Yorkville case.

And I have no doubt that the SEC is taking a closer at private equity funds and hedge funds. At a minimum, the SEC has a window into these fund now that fund managers have registered with the SEC.