The Securities and Exchange Commission's Asset Management
Unit has been investigating whether hedge fund managers have overvalued assets
in "side pockets" and then charged investors higher fees based on those
inflated values. A side pocket is a type of account that hedge funds use to
separate certain illiquid investments from the rest of their portfolio. Investors
are typically not permitted to redeem their interest in a fund with respect to
assets allocated to a side pocket until such assets have been liquidated or
reallocated to the general portfolio by the investment manager.
Recent charges brought by the SEC highlight the need for
hedge fund managers to establish reasonable policies for the valuation of
illiquid assets and carefully adhere to such policies when valuing assets
allocated to a side pocket. On October 19, 2010, the SEC
charged two hedge fund managers and their investment advisory businesses
with defrauding investors by overvaluing illiquid fund assets they placed in a
side pocket. According to the SEC complaint, Paul T. Mannion, Jr and Andrews S.
Reckles, through their investment adviser entities PEF Advisors Ltd. and PEF
Advisors LLC, caused certain investments made by Palisades Master Fund, L.P. to
be overvalued by millions of dollars.
SEC Targets Use of Side Pockets by Hedge Funds in
its entirety on Investment Fund
Law Blog, providing updates and insights on legal issues facing fund
managers and investors.