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UK hedge fund to take on Securities and Exchange Commission


Date: Tuesday, April 29, 2008
Author: Ben Laurance, Times Online

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On one level, it appears almost comical – a tale that manages to draw in Harry Potter’s enemy Lord Voldemort, Shakespeare and a series of TV shows.

On another, it is a story that involves some of the most arcane aspects of investment practice.

At the heart of it is a transatlantic dispute that has put a London-based hedge fund at loggerheads with Wall Street’s regulator, the Securities and Exchange Commission (SEC).

At stake are hundreds of millions of dollars; and the row promises to reignite the fierce debate about the right of American authorities to flex their muscles beyond the US.

The SEC is accusing Headstart Advisers, a hedge fund based in London’s Chelsea, of orchestrating a scheme to defraud shareholders in US mutual funds. Also in the watchdog’s sights is Headstart’s investment adviser and sole director, Najy Nasser.

And how does the SEC’s lawsuit bring in a Harry Potter character? Because, according to the claim, Headstart opened accounts with US broker-dealers with names that bore no relation to itself to disguise its activities.

Names included Voldermort – a slightly-misspelt version of the boy wizard’s archenemy – and the more prosaic Marks Securities and Spencer Securities.

Other areas to trawl for cover names were “Shakespeare, TV shows or comics”, said a Headstart document giving staff ideas about setting up new accounts.

The SEC’s claim involves dealings in mutual funds by Headstart between 1998 and 2003.

The commission makes two main accusations: First, it says Headstart, through two US broker-dealers, routinely engaged in “late trading” of mutual funds.

The price of US mutual funds is typically set at 4pm New York time, and is based on the fund’s net asset value at that time. According to the SEC, Headstart would place orders to try to buy after that time – at the price that had already been determined.

So if some piece of news broke after the 4pm cut-off – news that was likely to lift the fund’s value the next day – Headstart would be guaranteed to make a gain.

According to the SEC’s claim: “This illegal practice enabled Headstart Fund to profit – at the expense of other shareholders in the US mutual funds – from market events that occurred after 4pm, but that were not reflected in the price that Headstart Fund paid for the mutual fund shares.”

Second, the SEC accuses Headstart of “using deceptive techniques” to hide so-called “market timing” – dealing in funds invested in equities listed on bourses in different time zones.

This is aimed at exploiting the fact that the price at which units in a fund are bought or sold does not immediately reflect changes in the value of underlying assets.

US mutual funds have tried to deter market timing; they monitor deals above a certain size to try to catch investors trying to exploit the system.

According to the SEC claim, Headstart “opened numerous accounts on behalf of the Headstart Fund at various US broker-dealers, and split Headstart Fund trades among multiple accounts to keep the size of the trades below the threshold and conceal the extent of Headstart Fund’s trading from US mutual fund companies”.

In essence, the SEC says Headstart tried to evade mutual funds’ efforts to prevent market timing by keeping its trades small and disguised – below the radar of those trying to stop such deals.

The commission claims Headstart opened more than 500 brokerage accounts with at least 10 broker-dealers “for the purpose of market timing US mutual funds”. It says Nasser, 39, “provided instructions to, or otherwise communicated with, registered representatives at US broker-dealers in order to direct Headstart Fund’s late trading and deceptive market timing of US mutual funds”.

Market timing is not itself illegal, but it is illegal for an investor to use deception to lure a mutual fund to accept trades it would otherwise have refused under its own market-timing policies.

The SEC goes on to allege that Nasser and Headstart “benefited from this late trading and deceptive market timing at the expense of other shareholders in the US mutual funds. Headstart Fund earned illicit profits of approximately $198m (£99m) from its late trading and deceptive market timing . . . [AND] obtained ill-gotten gains”.

Nasser, a graduate of the London School of Economics who lives in Monaco, is chief investment adviser to Headstart which runs funds domiciled in the Caribbean. He refused to comment to The Sunday Times.

The SEC mounted an aggressive push against market timing in 2003. The commission was then headed by Eliot Spitzer – who was recently forced to resign as governor of New York after being caught up in a call-girl scandal.

A number of hedge funds, broker-dealers and mutual funds were investigated for alleged involvement in late trading. About 20 firms have reached settlements totalling more than $4 billion in fines, penalties and cuts in fees for investors.

The SEC asked for information from Headstart in late 2003. The following year, Headstart gave evidence to the Financial Services Authority in London, which was also looking at the issue. The FSA found there was no evidence of late trading, and only limited signs of market timing.

Last year, the SEC made a fresh approach to Headstart to secure a settlement. Negotiations opened and Headstart thought it was on the verge of striking a deal; a sum was agreed, but the two sides could not agree what should be said alongside a settlement.

Paul Fallon of City Law, Headstart’s solicitors, said: “We are not prepared to have a public statement saying we did something improper . . . we are not going to allow the SEC to impugn the good name of the company.”

Headstart does not accept it misled mutual funds to do market-timing deals. The hedge fund insists that the FSA found nothing seriously amiss when it investigated the issue in 2004.

And it refutes the charge it was involved in late trading. Fallon said: “The SEC has not found any particular instance of an order being placed after 4pm.”

City Law thought it was close an agreement, but on April 2, news agencies reported the SEC had launched civil proceedings against Headstart. The following day, papers detailing the claim arrived at City Law’s offices.

Headstart is not the only fund run from the UK to be targeted by the SEC. The day after its move against Headstart, the regulator filed a suit against Pentagon Capital Management and its chief executive Lewis Chester.

The SEC claimed Pentagon netted $62m in “ill-gotten gains”.

Pentagon insisted it had done nothing wrong, but the firm has closed all its 17 hedge funds, which together had $2.2 billion under management.

Headstart has until the end of June to respond to the SEC lawsuit. It is expected to ask for the claim to be struck out.