This is Not Compliance

UPDATE (9/10/2019):

The CEO/CCO in question contacted me and told me her side of the story with regards to the SEC. According to her, an investor sued based on the SEC case and the charges were largely dismissed. As I point out and have now highlighted, I relied on the order to illustrate what the SEC does not like and what you should not do. At her request, I’ve edited the post and removed her name. 


Sometimes you see a careless disregard for the rules governing private funds and investment advisers. Last week, the CEO/CCO of Calhoun Asset Management, settled fraud charges with the Securities and Exchange Commission. Her problems are probably common for start-up managers.

Calhoun and the CEO/CCO entered into an Order Making Findings (.pdf) with the SEC, but neither admitted nor denied the facts. I’ll assume the statements in the Order are true for educational purposes.

Assets Under Management

In 2006, the CEO/CCO started two hedge funds: Triumph Multi-Series Fund (later renamed Calhoun Multi-Series Fund LP) and Calhoun Market Neutral Fund. CEO/CCO attracted capital to the Funds by aggressively marketing herself as an experienced hedge fund manager, despite having no experience in portfolio management.

In filling out a due diligence questionnaire for a potential investors, CEO/CCO state that the firm grew from $27 million in assets under management in 1999 to $200 million. However, the firm never had more than $3 million in assets under management.

I understand the desire of fund managers to puff up the AUM number. After all, that dollar amount often stands for measure of success. However, the calculation of AUM needs to be documented and defensible. Lies can easily be detected and puffery will raise red flags.

Performance

The fund marketing materials refer to a 10-year track record with 11+% average annual returns. The CEO/CCO failed to maintain the documentation supporting this track record. CEO/CCO only maintained records dating back to 2007. In a PowerPoint presentation, CEO/CCO included a full-page chart of monthly and annual performance returns from 1999 through 2009. The legend at the bottom of the page states that “[t]hese returns represent our flagship fund, Calhoun Fund SPC, Ltd.” Calhoun Fund SPC, Ltd. However, the fund did not commence operations until January 1, 2007.

The SEC rules are very clear that any statements in marketing materials about performance must be well documented. Calhoun’s overstatement should be easily detected with a little due diligence by a prospective investor.

Due Diligence

Calhoun promoted its due diligence capabilities in its marketing materials. This included regular monitoring, performance reviews, and on-site visits. “We take every precaution necessary to complete thorough due diligence and research on every manager we recommend” (emphasis in original).

The truth was that Calhoun’s actual due diligence was virtually nonexistent. CEO/CCO did not even perform the due diligence herself. Instead, she outsourced the due diligence to a third party, and that third party did little actual diligence.

Form ADV

Of course, lying to the SEC will really get you. On the Forms ADV she filed with the SEC, CEO/CCO repeatedly misrepresented  assets under management.

CEO/CCO first registered Calhoun as an investment adviser on August 31, 2007. On Calhoun’s Form ADV, CEO/CCO stated that Calhoun had $30 million in assets under management. In reality Calhoun had less than $6 million under management. On February 18, 2009, CEO/CCO filed an amendment to the ADV showing $79.8 million in assets under management. In reality, Calhoun had approximately $7 million under management.

Lessons?

Lying is bad. Unlike a fisherman’s tale about the one that got away, fund managers are expected to document their tales in detail.

CEO/CCO has to pay a $50,000 fine and is barred from the securities industry for five years.

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