• SEC Files Enforcement Action against Investment Advisor
  • April 8, 2008 | Authors: Janaki R. Catanzarite; Matthew R. Silver
  • Law Firm: Pepper Hamilton LLP - Philadelphia Office
  • It was another example of “buyer beware” when theSECfiled an enforcement action in Utah federal court against Thompson Consulting, Inc., two of its key employees, an advisory affiliate and several “relief defendants” for making undisclosed high-risk investments that resulted in the near total loss of assets for two hedge funds managed by Thompson. Securities and Exchange Commission v. Thompson Consulting, Inc., Case Number 2:08-cv-00171 (D.Ut. filed March 4, 2008). 

    The SEC’s complaint seeks to enjoin Thompson and the other defendants from future violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Sections 206(1) and (2) of the Investment Advisers Act of 1940 and seeks the imposition of civil penalties, payment of disgorgement and prejudgment interest by the defendants, and disgorgement from the relief defendants.

    The SEC’s complaint alleges, among other things:

    • Thomson had represented that it would safely invest client funds through a “short straddle or strangle” strategy whereby it would write offsetting put-and-call option contracts on underlying market indexes such as the S&P 500 and that it would closely track the movement of the indices and close-out positions that were deemed too risky. On at least one occasion, either Thompson’s President/CCO/Chief Trader or its in-house legal counsel, both of whom solicited investors and both of whom are named as defendants, stated, in effect that due to Thompson’s trading strategy, there would have to be a complete collapse of the free market system in the United States for their main hedge fund to loose principal. Thompson informed investors that projected returns would to be in the range of 3 percent a month.
    • Contrary to its representations, Thompson engaged in trading significantly unlike what the company described to investors, resulting in losses exceeding $53 million. In an attempt to attain the promised 3 percent monthly returns, Thompson engaged in progressively risky strategies (without disclosure to investors), including failed investments in options on the stock of a subprime lender, which later collapsed. 
    • Thompson transferred millions from the hedge funds to a private client’s account to make up for the losses incurred by the private client in the same subprime lender options.
    • In an effort to recoup losses by the hedge funds, Thompson later invested virtually all the hedge funds’ assets in unhedged options on the Chicago Board of Options Exchange volatility index, which the securities market’s sharp drop largely wiped out in mid-August 2007.
    • From July 31 to Aug. 17, 2007, the net asset value of the hedge funds fell from approximately $54 million to approximately $200,000.

    Pepper Points -  Investors with sufficient money and sophistication to invest in a hedge fund should be concerned about an investment with no stated principal risk if the projected return, in today’s market, seems to good to be true. It also is important to make sure investors read the most current version of a fund’s private placement memorandum and all supplements. If you do not understand the strategy and its risks, do not invest. Investors also should verify that company documents reflect the current investment strategy of the fund.