Hedge Fund Adviser to Pay $5 Million for Compliance Failures Related to Valuation of Fund Assets

The Securities and Exchange Commission today announced that a private fund manager in the mortgage-backed securities space has agreed to pay a $5 million penalty to settle charges stemming from compliance deficiencies that contributed to the firm’s failure to ensure that certain securities in its flagship fund were valued properly.

The fund manager’s chief investment officer (CIO) agreed to pay a $250,000 penalty.

An SEC investigation found that Colorado-based investment adviser Deer Park Road Management Company LP, in connection with its flagship STS Partners’ fund which has been ranked as one of the most consistent performing hedge funds in the country, failed to have policies and procedures to address the risk that its traders were undervaluing securities and selling for a profit when needed.  The firm also failed to guard against its traders’ providing inaccurate information to a pricing vendor and then using the prices it got back to value bonds.  CIO Scott Burg oversaw the valuation of certain assets in the flagship fund and approved valuations that the traders flagged as “undervalued” with notations to “mark up gradually.”  Also overseeing valuation was a committee comprised of the principal’s relatives and others without relevant expertise.

“Valuation of client assets is a critically important area for investment advisers,” said Daniel Michael, Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit.  “Deer Park’s pervasive compliance failures allowed its traders to mark assets up gradually instead of marking them to market, in violation of the accounting principles they were required to follow.”

Without admitting or denying the findings in the SEC’s order, Deer Park consented to a censure and Deer Park and Burg agreed to cease and desist from committing or causing any violations and future violations of a provision of the Investment Advisers Act requiring reasonably designed policies and procedures.

The SEC’s investigation was conducted by William Finkel and Gregory Smolar of the Complex Financial Instruments Unit and Douglas Smith of the New York office with assistance from Ling Yu of the Office of Compliance Inspections and Examinations as well as Dugan Bliss and Christopher Dunnigan.  Osman Nawaz and Mr. Michael supervised the case.