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Ex-Third Point Partner’s Bond Trades Focus of SEC Probe

Updated on
  • SEC is said to review valuations of Keri Findley’s investments
  • U.S. has been scrutinizing illiquid bonds across Wall Street

U.S. regulators are investigating whether a top trader who left Dan Loeb’s Third Point hedge fund earlier this year contributed to the mispricing of hard-to-value mortgage bonds, two people familiar with the matter said.

The Securities and Exchange Commission is probing whether former Third Point partner Keri Findley caused the thinly traded bonds to be undervalued, said the people who asked not to be named because the probe isn’t public. Findley, 35, left the $18 billion firm in February, telling people who had direct communications with her that she was retiring and moving to California.

The SEC probe is preliminary and won’t necessarily lead to any allegations of wrongdoing. Findley hasn’t been contacted by the regulator, according to people familiar with the proceedings. Third Point said in a statement that it has provided documents and other information to the agency and will continue to do so. The firm added that it has a rigorous process for pricing securities that relies on data from independent parties.

“All of our asset-backed securities marks are provided by third-party pricing services and/or independent broker-dealers,” Third Point said in its statement.  “Our valuation process has been designed with the assistance of specialist consultants, and requires our Valuation Committee to subject positions to extensive monitoring and back-testing.  In addition, prices are subject to review by our third-party administrator and, ultimately, our independent auditors.”

An SEC spokeswoman declined to comment as did a spokesman for Findley.

Managing Billions

Findley joined New York-based Third Point in March 2009 and was made one of only four partners at the end of 2015. She managed as much as 20 percent of the firm’s assets during her tenure, a total that amounted to billions of dollars. In 2014, her portfolio accounted for roughly half of Third Point’s profits.

It isn’t clear why certain holdings Findley invested in may have been marked down. Most cases of mismarking involve overvaluing assets -- which allow firms to make higher performance fees, and enables traders to earn bigger bonuses.

Undervaluing could be done to inappropriately smooth returns, according to traders and securities lawyers. For instance, a trader might cause a bond’s valuation to be lowballed at the beginning of the year, and then increased later to offset losses on other holdings in his or her portfolio. By year end, the proper price would be used to calculate fees and bonuses.

Likewise, if a trader expected to have to sell securities in the near future, he or she might want to carry those positions at a lower price ahead of the sale.

Industry Probe

The investigation is the latest in a series of probes examining how Wall Street banks and hedge funds value bonds that aren’t bought and sold on exchanges, and may go months without trading. The lack of transparency prompts funds to rely on price estimates from brokers and quotes from third parties. The SEC and federal prosecutors are concerned the system is rife with abuse, and have sanctioned multiple traders in recent years.

This year, Third Point has has been exiting credit positions as the firm has seen more opportunity in the surging stock markets. Last month, 15 percent of its assets were in bonds compared with 30 percent at the end of 2016, according to disclosures on the fund’s website.

Historically, the SEC monitored stocks much more closely than bonds, due to the regulator’s focus on protecting mom-and-pop investors who predominantly bought equities. The agency viewed the debt market as being filled with more sophisticated investors who could fend for themselves.

The SEC began paying more attention to bonds during the 2008 financial crisis after realizing that many investors weren’t as savvy as it had assumed. Banks, insurers and fund managers lost billions of dollars amid the meltdown due to plummeting prices for mortgage securities.

Better Technology

Technological advancements have helped the SEC. In recent years, it has been using computer algorithms to detect anomalies in trading of bonds tied to mortgages, auto loans and other kinds of debt. SEC officials have said the algorithms have helped the agency identify billions of dollars of problematic trades.

Mismarking was at the center of a 2016 case against employees at hedge fund Visium Asset Management. One analyst, Stefan Lumiere, was accused of soliciting sham quotes from friendly brokers to justify inflated valuations on distressed-debt holdings. In June, a federal judged sentenced him to 18 months in prison.

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