The Securities and Exchange Commission (SEC) filed a securities fraud complaint against Yorkville Advisors LLC, a former $1 billion hedge fund advisory firm. The commission also charged Mark Angelo, founder and president of the firm and Edward Schinik, chief financial officer of the company.

sec us securities and exchange commission

The SEC alleged the two executive allegedly committed conspiracy to hide losses and to increase the fees collected to investors by overvaluing assets under management and inflating  the reported returns of the hedge funds they managed. Based on the complaint of the SEC, Yorkville “improperly received more than $10 million unearned fees from the funds.”

According to the Commission, the two executives started reporting false and inflated valuation for convertibles (convertible debentures & convertible preferred stock), and promissory note investments held by hedge funds in 2008 by changing the firm’s valuation methodology.

The SEC claimed that Angelo and Schinik lured investors including pension funds to invest approximately $280 million in their hedge funds by misrepresenting Yorkville as a company with “highly, collateralized investment portfolio and uses robust valuation procedure.”

In addition, the two executives allegedly persuaded investors who wanted to redeem their investments in Funds to participate in a special redemption fund, which allowed the Yorkville to receive additional fees. They also submitted fake and misleading documents and withheld investment information to the auditor of the Fund.

The Commission further alleged that Yorkville failed to comply with its valuations policies and ignored negative information about certain investments by YA Global Investments (U.S.) LP and YA Offshore Global Investments Ltd hedge funds.

In a statement, Bruce Karpati, Chief of the Enforcement Division, Asset Management Unit of SEC said, “The analytics put Yorkville front and center on our radar screen. When we looked further, we found lies to investors and the firm’s auditors as well as a scheme to inflate fees by grossly overvaluing fund assets. We will continue to pursue hedge fund managers whose success is based on fiction rather than fact.”

According to Forbes, Yorkville Advisors was one of the biggest hedge funds with expertise in making private investments in public equities particularly penny stocks, and reported strong returns monthly from 2001 to 2008. In 2010, Yorkville reported a stunning 33 percent drop in returns, which prompted the SEC investigation. At the time, the consolidated financial statement of the Fund indicated $804 million worth of investments.

Meanwhile,  sources familiar with the matter told us that many large hedge funds apply complicated valuation strategies to increase the value of their assets in order to charge fees. According to the sources, many of these hedge funds do not report assets within fair value, which was the convertible option, stripped out of debt. They practice it as long as they have access to “borrow” as collateral to a hypothetical sale of the underlying shares of the convertible stock. This case might just be the tip of the iceberg.