Fraud in Valuing Side Pocket

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!