Side Pockets Get Uncomfortable SEC Attention

Apr 28 2010 | 8:08am ET

The Securities and Exchange Commission is investigating hedge funds’ use of side-pockets during the financial crisis.

A new SEC enforcement unit focused on asset managers is working on two side-pocket cases it plans to bring before the Commission within six months, The Wall Street Journal reports. The regulator is also continuing its probe into New York-based hedge fund Ram Capital Resources’ use of side-pockets.

Face with big losses and even bigger redemptions amidst the subprime mortgage crisis in 2008, many hedge funds moved their illiquid assets into side-pockets, barring investors from exiting those investments. But investors complained that many hedge funds provided little information about the assets they were gating or why they were doing so, all the while charging fees on them, according to the Journal.

Those fees are also facing SEC scrutiny, as the regulator investigates whether hedge funds inflated the value of their illiquid holdings to charge higher management fees.

In addition to all matters side pocket, the agency is also probing hedge funds’ asset valuation and disclosure practices, as well as whether managers are being truthful about their own investments in their hedge funds.

The SEC is focusing on third-party administrators, auditors and offshore directors in its side pocket investigation, including on whether those directors may have breached their fiduciary duties. In the Ram Capital case, the agency has subpoenaed investors in two funds, seeking e-mails from the firm, marketing materials and investor letters.

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