BlueCrest Inquiry Highlights Internal Fund Risks

By Rachael Levy February 10, 2016

A fund for employees at BlueCrest Capital Management has apparently caught the attention of the Securities and Exchange Commission – and highlights the risks hedge fund managers face in offering internal funds, compliance experts say.

The SEC is querying Michael Platt’s BlueCrest about potential conflicts of interest in an internal fund set up for the firm’s partners, according to a Bloomberg report.

BlueCrest, based in the Channel Islands jurisdiction of Jersey, was once one of the world’s largest hedge fund firms but lost significant assets last year, as reported. Platt announced the firm would return all investor capital and become a family office in December, after it ended up with $8 billion under management, down from its $37 billion peak in May 2013.

A BlueCrest spokesman declined to confirm the existence of the SEC probe, but said in a statement that the firm had “received a number of queries, including from the SEC as well as from its other regulators” after the firm announced it would become a family office in December. “BlueCrest is fully cooperative with all of its regulators and to date has received no accusation of wrongdoing,” the statement added. The SEC didn’t respond to a request for comment.

The SEC isn’t the first to question BlueCrest’s internal fund, called the BlueCrest Staff Managed Account. In 2013, consulting firm Albourne Partners raised concerns about the fairness of the fund, which had reportedly outperformed the firm’s private funds for external investors, as reported. BlueCrest has said that it made proper disclosures about the internal fund.

Many hedge fund firms provide access to their investment strategies as an employee perk, says Jason Rosenberg, senior principal consultant at ACA Compliance Group. Some, such as Renaissance Technologies, have allowed employees to use their retirement accounts to access coveted strategies, as reported.

But few managers take BlueCrest’s approach of launching a fund just for staffers, says Samuel Won, managing director of investment risk management at Global Risk Management Advisors. The questions that can arise – whether the internal fund is getting the jump on better investment ideas, for example – make the arrangement less than ideal, Won says.

“Optically, it’s not a good idea,” he says. “It can be misconstrued by investors.”

That’s not to say there isn’t a way to set up internal funds. Proper disclosures across investor documents and regulatory filings are necessary, ACA’s Rosenberg says.

“It’s very key that no client is disadvantaged in any way, that all clients are treated fairly with regards to trading and investment allocation,” Rosenberg says. “You really have to have good controls in place in order to mitigate the conflict.”

The SEC is concerned about whether firms are making appropriate disclosures about their internal funds to external investors entering the private funds, particularly if those investors are paying different fee rates, Rosenberg says. Internal funds can offer lower fees, as long as they are disclosed, he says.

How much firms should disclose about different fees is a “gray area,” but Rosenberg recommends acting with caution.

“Make it very clear,” he says. “More disclosure is better than less because you don’t want to get in a situation where you’re being investigated by the SEC and your [limited partners] were unaware of this relationship.”

Managers must also make sure that the allocation of investment opportunities between internal and external funds is fair, he adds. “You don’t want to disadvantage the public funds. You want to treat both funds the same; you can’t cherry pick.”

Hedge fund firms should also make sure they have appropriate monitors in place over the funds, and avoid placing staffers in dual roles where their priorities may compete against one another, such as having a trader who also has an administrative job, says Gigi Szekely, managing director of compliance at IMP Consulting. “There needs to be a segregation of responsibilities,” she adds.

The BlueCrest inquiry comes at a time when the SEC has proven it is willing to go after big-name hedge funds, including Och-Ziff Capital Management last year over supplying incorrect data to its prime brokers and S.A.C. Capital Advisors in 2013 for insider trading violations.

The agency also has gone after other big alts firms. Last year, KKR settled with the regulator for $30 million after it failed to disclose broken deal expenses to investors. And Blackstone Group settled with the agency after it failed to disclose information about accelerated monitoring fees on portfolio companies, as reported.

Still, it’s unlikely the SEC is targeting high-profile firms as example-setting alone, says Steven Nadel, partner in the investment management group at law firm Seward & Kissel.

“The SEC, as far as I know, is agnostic,” he says. “Some of this happens to be coincidental. Bigger managers have bigger infrastructures, more clients, and are more likely to have conflicts.”