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SEC prosecutes investment advisors over US$1 billion trading loss

Chris Hamblin, Editor, London, 2 June 2021

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The US Securities and Exchange Commission has taken two portfolio-managers-cum-investment-advisors, Anthony Caine and Anish Parvataneni, to court for presenting a false narrative to HNW investors about the risks involved in their mutual fund and other private funds.

The case, for which the SEC demands a jury trial, is to be judged by the US district court for Northern Illinois. Parvataneni, 48, and Caine, 63, based their operations in Chicago. Their firms, LJM Funds Management Ltd and LJM Partners Ltd, are also defendants.

In its complaint to the court, of which Compliance Matters has seen a copy, the SEC claims that the parties neglected their fiduciary duties and were dishonest regarding the risks inherent in an options trading strategy that they employed as investment advisors to a mutual fund, the LJM Preservation & Growth Fund (estd 2013, liquidated 2018) and/or several private investment funds, which collectively suffered more than a billion dollars of losses in February 2018.

Allegations of fraud, deceit and/or the deliberate or reckless disregard of regulatory requirements have resulted in charges that the defendants contravened section 10(b) Securities Exchange Act 1934 and Rule 10b-5 thereunder, section 17(a) Securities Act 1933, sections 206(1), 206(2) and 206(4) Investment Advisors Act 1940 and Rules 206(4)-7 and 206(4)-8 thereunder, and sections 15(c) and 34(b) Investment Company Act 1940.

LJM Management served as the investment advisor to the big fund and LJM Partners was the advisor to the others, along with some separately managed accounts or SMAs. The two firms shared office space, officers, portfolio managers and employees.

The investment strategy involved writing (i.e. selling) short-dated, out-of-the-money put options (and some call options) on S&P 500 futures contracts. Caine first offered this alternative investment strategy to high net-worth individuals, trusts, and institutional investors.

Like an insurance company, LJM Management and LJM Partners made money by collecting premia (i.e., the market prices of the options) in exchange for assuming a risk – in this case, the obligation to purchase or sell futures contracts at a given strike price if the option holder exercised the option on or before the expiration date. This “short options” or “short volatility” trading offers investors relatively stable profits from premium income, but carries the risk of significant losses during large market swings. The strategy was the equivalent of selling insurance to other investors, primarily against declines in the S&P 500 futures market. Caine offered annual targeted returns of 8-12% for a basic stragety, 18-24% for a "moderately aggressive" strategy and more than 24% for an "aggressive" strategy.

The defendants told the investors that: (a) they stress-tested the portfolios against past figures to estimate worst-case daily losses; (b) on the basis of these stress tests, the estimated worst-case daily loss was 20% for the P&G Fund and 30-35% for the private funds; and (c) they managed these funds to maintain consistent risk levels. All these marketing assertions, according to the SEC, were false.

LJM did automatically generate stress tests that used past data on every trading day but, according to the SEC, the calculations it did with them were dishonest. To arrive at the 20% estimated worst-case daily loss for the P&G Fund, for example, it allegedly took the fund’s worst performance on a single day (approximately 9%), doubled it, and then rounded up. Indeed, on nearly every trading day between late 2016 and early 2018, the actual stress tests allegedly showed potential losses greater than the estimates that the investors received. Eventually, the inevitable happened: in February 2018, the financial markets suffered a large spike in volatility over two consecutive trading days. The funds  suffered catastrophic trading losses of more than US$1 billion or approximately 80% of their value.

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