The SEC's New Approach to Fraud

The SEC mines data to detect dodgy hedge fund activity

A new government system for spotting securities fraud is bearing fruit. Over the past month the Securities and Exchange Commission filed four fraud cases against three hedge funds and six people for misconduct, including improper use of assets, fraudulent valuations, and misrepresenting returns. “Hedge fund managers depend on valuation and performance for both their compensation and marketing,” says Bruce Karpati, co-chief of the SEC’s asset-management enforcement unit. “These managers have either manipulated performance or engaged in other falsehoods in order to line their own pockets at the expense of investors.”

The actions are a product of the agency’s initiative to build cases on data analysis instead of relying on tips. “We take a look at performance by comparing funds against their peers and then apply qualitative factors, including looking at experience, assets under management, their regulatory history, and whether they’ve been in trouble before,” Karpati says.

In the most recent enforcement action stemming from the program, the SEC on Dec. 1 filed a lawsuit against Michael R. Balboa, former portfolio manager for the now defunct $844 million Millennium Global Emerging Credit Fund. The lawsuit alleges that he and Gilles De Charsonville, a broker at Greenwich (Conn.)-based BCP Securities, along with an unidentified third person used overvalued securities positions to “generate millions of dollars in illegitimate management and performance fees.” Balboa was also arrested and charged with securities fraud, according to a criminal complaint unsealed in federal court in New York on Dec. 1. Balboa, 42, of Surrey, England, will plead not guilty and “intends to defend the charges,” his lawyer, Joseph Tacopina, says. An attorney for De Charsonville, 49, of Madrid, didn’t immediately respond to a request for comment.

Adam J. Wasserman, a New York attorney at Dechert who works with hedge funds, says fund managers could have concerns if achieving unusually good returns—“doing their job well”—sprouts a red flag at the SEC. “People invest in hedge funds because they expect better returns over time,” Wasserman says. “You don’t want traders and their funds to fear being successful.”

In a speech to the Consumer Federation of America on Dec. 1, Robert S. Khuzami, the SEC’s enforcement director, likened the program to former New York City Mayor Rudy Giuliani’s so-called broken windows approach to crime fighting, which operated on the theory that targeting routine violations would curtail major crime. “If you stop people when they commit small infractions,” Khuzami said, “they are less likely to graduate to bigger ones.”


    The bottom line: Using data mining to spot suspicious activity, the SEC has filed four fraud cases against three hedge funds and six people in the past month.

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