U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 19510 / December 22, 2005
Securities And Exchange Commission v. Brent William Federighi and Michael Carl Hoffman, United States District Court for the Northern District of California, Civil Action No. C 05-05305 MMC
SEC Charges San Francisco Hedge Fund Managers with Fraudulent Mutual Fund Trading Scheme
The Securities and Exchange Commission today filed civil fraud charges against two former San Francisco hedge fund managers. The SEC alleges that the fund managers defrauded scores of mutual funds and their shareholders of approximately $49 million when they placed thousands of illegal "late trades" after the close of the market, which enabled the managers to trade based on after-market events while still obtaining the prices in effect before the market closed. According to the Commission, the fund managers also fraudulently engaged in "market timing," by which they placed frequent short-term trades prohibited by the mutual funds and burdened other shareholders with unfair costs as a result.
The Commission's complaint, filed in the United States District Court for the Northern District of California, names Brent W. Federighi, 34, and Michael C. Hoffman, 42, both of San Francisco, in connection with their conduct between 2000 and 2002 on behalf of the Ilytat hedge fund, which they co-managed and which closed in August 2002, and in connection with Federighi's conduct from September 2002 to October 2003 in managing the Gage Capital hedge fund after Ilytat closed. In May 2001, Ilytat's domestic and offshore funds had a total of approximately $130 million in assets, and when Gage closed in 2003 it had approximately $55 million in assets in its domestic and offshore funds.
According to the Commission's complaint, Federighi and Hoffman deliberately exploited a loophole in their broker's mutual fund order entry system to place over 3,000 fraudulent late trades (representing over 80% of their hedge funds' mutual fund trades) in over 400 different mutual funds, allowing them to obtain better prices for their mutual fund shares than other investors received. The late trading by Federighi and Hoffman caused losses of approximately $49 million to other mutual fund investors through the hedge funds' improper receipt of stale fund prices. Some trades were placed as late as 5:45 p.m. (Eastern Time), or 1.75 hours after the time as of which the mutual funds' prices were set.
In addition, Federighi and Hoffman allegedly engaged in short-term trading in mutual funds, in violation of the mutual funds' rules. When the mutual funds discovered this improper market timing, they restricted or barred Ilytat and Gage from investing in the funds. Federighi and Hoffman then allegedly used deceptive techniques to conceal the hedge funds' identities in order to continue market timing those funds. Among other things, Ilytat and Gage placed trades using multiple, non-consecutively numbered accounts to conceal their identities from the funds.
Specifically, the complaint alleges that by engaging in the conduct described above, Hoffman and Federighi violated Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder, Sections 206(1) and 206(2) of the Advisers Act of 1940, and Section 37 of the Investment Company Act.
The Commission seeks to enjoin defendants from committing future violations of these provisions, disgorgement of all ill-gotten gains plus prejudgment interest, and civil monetary penalties.
SEC Complaint in this matter