Hedge Fund Exec. In Hot Water Over Mom's Referral Fees

Mar 14 2008 | 1:12am ET

The Securities and Exchange Commission recently brought to light a mother-and-son hedge fund scam that has left more than a few scratching their heads.

The scam involves the failure of Michael Donnell to disclose a conflict of interest stemming from a sub-adviser’s payment of substantial “referral fees” to Donnell’s mother.

From March 2002 until his termination two years later, Donnell served as a vice president of Mercantile Capital Advisors, a registered investment adviser that manages a fund of hedge funds—the Mercantile Fund.

During his time at Mercantile, Donnell recommended hiring a sub-adviser, who happened to be a family friend who had experience investing in hedge funds. As part of an undisclosed deal to get the gig, the friend promised to pay a substantial portion of any sub-advisory fees to Donnell’s mother as ‘referral’ fees. Of course, the payments created a conflict of interest, but Donnell did not disclose the deal to anyone at Mercantile Advisors or to the board of directors of the Mercantile Fund.

Eventually, Donnell’s mother received payments totaling about $78,000, which was over one-third of the fees received by the sub-adviser. Donnell’s shenanigans ended when Mercantile Advisor’s parent company, Mercantile Bankshares Corp., and the SEC received anonymous letters disclosing the payments.

Donnell has been barred from associating with any investment adviser for a period of three years and is also ordered to pay a $50,000 civil money penalty. 

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