Last week SEC charged two hedge fund portfolio managers and their investment advisory businesses with defrauding investors in the Palisades Master Fund, L.P. by overvaluing illiquid fund assets they placed in a "side pocket."
SEC alleges that the hedge fund managers Paul Mannion and Andrews Reckles placed the Palisades hedge fund's investments in World Health Alternatives Inc. in a side pocket and valued those investments in a manner that was inconsistent with fund policy and contrary to an undisclosed internal assessment. They also stole investor money to pay for their own personal investments and made material misrepresentations in connection with a private securities transaction.
A side pocket is a type of account that hedge funds use to separate particular investments that are typically illiquid from the remainder of the investments in the fund. SEC's Asset Management Unit has been probing whether funds have overvalued assets in side pockets while charging investors higher fees based on those inflated values.
According to SEC's allegations:
- Mannion and Reckles stole more than approximately $1.6 million worth of warrants belonging to the fund. They also improperly used investors' cash on at least two occasions to make personal investments, and they deceived a securities issuer by making false representations about their trading positions in order to participate in a private offering by the issuer.
- Mannion and Reckles defrauded investors for at least a three-month period in 2005 through PEF Advisors LLC and PEF Advisors Ltd., two investment adviser entities they controlled. The fraudulent valuations of a convertible debenture, restricted stock, and bridge loans enabled Mannion and Reckles to report to investors misleadingly inflated net asset values, allowing them to take excessive management fees from the fund.
Jack's comment: That is one of the reasons why hedge fund managers are richer than their clients!
Last week SEC announced that former Countrywide Financial CEO Angelo Mozilo will pay a record $22.5 million penalty to settle SEC charges that he and two other former Countrywide executives misled investors as the subprime mortgage crisis emerged. The settlement also permanently bars Mozilo from ever again serving as an officer or director of a publicly traded company.
Mozilo's financial penalty is the largest ever paid by a public company's senior executive in an SEC settlement. Mozilo also agreed to $45 million in disgorgement of ill-gotten gains to settle SEC's disclosure violation and insider trading charges against him, for a total financial settlement of $67.5 million that will be returned to harmed investors.
Former Countrywide chief operating officer David Sambol agreed to a settlement in which he is liable for $5 million in disgorgement and a $520,000 penalty, and a three-year officer and director bar. Former chief financial officer Eric Sieracki agreed to pay a $130,000 penalty and a one-year bar from practicing before the Commission. In settling SEC's charges, the former executives neither admit nor deny the allegations against them.
The penalties and disgorgement paid by Sambol and Sieracki will also be returned to harmed investors.
SEC filed charges against Mozilo, Sambol and Sieracki on June 4, 2009, alleging that they failed to disclose to investors the significant credit risk that Countrywide was taking on as a result of its efforts to build and maintain market share. Investors were misled by representations assuring them that Countrywide was primarily a prime quality mortgage lender that had avoided the excesses of its competitors. In reality, Countrywide was writing increasingly risky loans and its senior executives knew that defaults and delinquencies in its servicing portfolio as well as the loans it packaged and sold as mortgage-backed securities would rise as a result.
SEC's complaint further alleged that Mozilo engaged in insider trading in the securities of Countrywide by establishing four 10b5-1 sales plans in October, November, and December 2006 while he was aware of material, non-public information concerning Countrywide's increasing credit risk and the risk regarding the poor expected performance of Countrywide-originated loans.
Jack's comment: Don't invest in financial stocks until their risks taken are sufficiently transparent to you.
During August 2010, FSTB issued the Consultation Paper on Proposed Establishment of an Independent Insurance Authority. This Monday (11 October 2010) was the due day for submission. I provided the comments to FSTB on behalf of the International Academy of Financial Management - Hong Kong Chapter ("IAFMHK"), which are set out as follows:
Consultation Questions
1. Do you agree that an independent IA should be established along the principles set out in paragraph 2.6?
IAFMHK: We agree to the establishment of an independent IA for more effective regulation of the insurance industry. This is in line with the regulatory practices of banking and securities industries in Hong Kong.
2. Do you think that there are other important principles in addition to those set out in paragraph 2.6 that the Administration should adopt in working out the detailed legislative proposals for the establishment of the independent IA? If so, what are they?
IAFMHK: We think that the independent IA should also adopt two more principles: (a) protection of the interests of insurance agents working for insurance companies; and (b) education of the general public about insurance products and industry practices.
3. Do you agree that the independent IA should have an expanded role beyond the existing functions of the IA as set out in paragraph 3.1? If so, do you agree that the independent IA should assume the additional functions as proposed in paragraphs 3.3 and 3.4?
IAFMHK: Agree, especially the independent IA should be able to directly supervise insurance intermediaries.
4. Do you agree the independent IA should also have a duty to enhance the competitiveness of the insurance industry, which will help to reinforce Hong Kong’s status as an international financial centre?
IAFMHK: The fundamental responsibility of the independent IA remain the enforcement of insurance regulations. However, it should adopt a pragmatic regulatory approach to avoid hindering the industry from product innovation and business versatility.
5. Do you agree that the independent IA should be vested with additional powers as proposed in paragraph 4.7 to enable it to regulate insurers more effectively?
IAFMHK: Agree. The additional powers are necessary for the independent IA to enforce the relevant laws and regulations.
6. Do you consider that the existing self-regulatory arrangements for insurance intermediaries should be changed, and if so, do you support that Option 2 (i.e. direct supervision of insurance intermediaries by the independent IA) should be pursued? If not, why?
IAFMHK: We support Option 2.
7. Do you consider that in relation to the sale of insurance products in banks, the HKMA should be vested with powers similar to those for the independent IA to allow HKMA to regulate bank employees selling insurance products given the different client profile and sale environment in banks?
IAFMHK: Different client profile and sale environment is not a sufficient reason to justify that sale of insurance products in banks should be regulated by the HKMA. For avoidance of regulatory arbitrage, sale of insurance products by insurance companies, insurance brokers, independent financial advisors and banks should be regulated by a single and specialist regulatory body.
8. Do you agree that the recommendations as set out in paragraphs 6.5 to 6.8 should be pursued for the independent IA to operate as an independent entity? Any other views?
IAFMHK: We largely agree to the recommendations but suggest that the incentive pay should be linked to the meeting of certain objective performance pledges.
9. Do you agree with the proposed checks and balances and governance arrangements for the independent IA as set out in this Chapter?
IAFMHK: We agree to the proposed checks and balances and governance arrangements. In addition, we suggest the establishment of a mediation and arbitration mechanism to resolve the commercial disputes among insurance companies, insurance intermediaries and/or insurance policyholders.
10. Do you agree that the Government should provide a lump sum to support the independent IA in its initial years of operation and the independent IA should seek to reach full cost recovery in six years?
IAFMHK: We agree that the Government should provide financial assistance to the support the independent IA in its initial years of operation. However, we suggest a longer period (say, 10 years) for full cost recovery to reduce the burden of the insurance industry.
11. Do you agree with the proposed fee structure as set out in paragraphs 8.2 and 8.6?
IAFMHK: We agree to the proposed fee structures.
Last week SFC started a two-month public consultation on proposals to expand the scope of the present requirements governing conflicts of interest for analysts so that not only research reports on listed securities but also those on IPOs are covered.
The proposed changes to existing regulatory requirements are summarized in SFC's consultation questions below. My initial comments are also provided.
1. Do you agree that the requirements in paragraph 16 of the Code of Conduct should be extended to cover research analysts in relation to Pre-deal Research reports?
Jack: It makes sense for paragraph 16 to cover analysts issuing pre-deal research reports as well.
2. Do you agree that the requirements of paragraph 16 of the Code of Conduct should be extended to cover research analysts covering proposed listings of and listed SFC-authorised REITs in Hong Kong?
Jack: It makes sense for paragraph 16 to cover research reports on REITs as well.
3. Do you agree that the firm employing research analysts preparing pre-deal research reports on a Applicant should be required to establish, maintain and enforce a set of written policies and control procedures to ensure that these analysts are not provided by the firm with any material information or forward looking information (whether qualitative or quantitative), concerning the Applicant that are not: (a) reasonably expected to be included in the prospectus; or (b) publicly available?
Jack: Agree, but SFC should issue some guidelines on (i) the benchmark for such policies and control procedures (e.g. additional Chinese Wall procedure); and (ii) what constitutes material information or forward looking information that will not be included in the prospectus or publicly available. Also, SFC should specify which party can make the final judgement on such unprovided information.
4. Do you agree that a research analyst preparing a research report on an Applicant should not seek to obtain from the Applicant or its advisers, any material information or forward looking information (whether qualitative or quantitative), that are: (a) not reasonably expected to be included in the prospectus; or (b) publicly available?
Jack: Ditto
5. Do you agree that the proposed amendments to Paragraph 16 of the Code of Conduct set out in Appendix 1 implement the above proposals?
Jack: The proposed amendments are not adequate. See above comments.
6. Do you agree that sponsors should take steps to ensure that all material information or forward looking information (whether qualitative or quantitative), disclosed or provided to analysts is contained in the relevant prospectus or where the proposed listing does not involve a prospectus the relevant listing document, offering circular or similar document?
Jack: Agree in principle, but what steps should be taken by sponsors? Shall a sponsor review the pre-deal research reports to ensure that all material or forward looking information provided to analysts is contained in the prospectus. If the reports contain information gathered by the analysts through their own due diligence, how can the sponsor confirm that such information is not obtained from the Applicant? If the sponsor reviews the research reports, would the independence of analysts be compromised?
7. Do you agree that the proposed amendments to the CFA Code of Conduct set out in Appendix 2 implement the above proposal?
Jack: The proposed amendments are not adequate. See above comments.
