A pair of hedge fund managers have been accused of using a side-pocket to conceal losses and overcharge investors.
The Securities and Exchange Commission said that PEF Advisors, run by Paul Mannion and Andrew Reckles, overvalued the hedge fund's investment in World Health Alternatives by more than a factor of 10. The Atlanta firm's Palisade Master Fund had about 20% of client assets invested in the company five years ago, when WHA announced that it was under investigation for accounting fraud.
PEF moved the WHA investment into a side-pocket as the stock's value plummeted by more than 90%. But according to the SEC, PEF continued to value the stake at $4.12 million, when it was worth $362,000, "at most."
"Side pockets are not supposed to be a dumping ground for hedge fund managers to conceal overvalued assets," the SEC's Robert Kaplan said. "Mannion and Reckles deceived investors about the fund's performance and extracted excessive management fees based on the inflated values."
According to the SEC, the duo stole some $1.6 million from investors using the side-pocket.
Mannion and Reckles deny the charges, arguing that "no valuation" of WHA "was reliable" following the announcement of the investigation and the company's subsequent bankruptcy filing.
The two men's attorney, Stavroula Lambrakopoulos, said that no money was lost by clients due to the use of the side pocket.
The case may be the first over the use of side-pockets, which became prevalent during the financial crisis, but it will not be the last. Kaplan said that "additional side pocket cases" are likely in the future.