The US Securities and Exchange Commission has charged San Francisco investment adviser MedCap Management & Research and its principal, Charles Frederick Toney, with reporting misleadin
The US Securities and Exchange Commission has charged San Francisco investment adviser MedCap Management & Research and its principal, Charles Frederick Toney, with reporting misleading results to hedge fund investors through a practice known as ‘portfolio pumping’.
The SEC alleges that Toney made extensive quarter-end purchases of a thinly-traded penny stock in which his fund was heavily invested, more than quadrupling the stock price and allowing him to report artificially inflated quarterly results to fund investors.
Without admitting or denying the SEC’s allegations, MedCap Management and Toney have agreed to settle the charges by paying financial penalties and agreeing to an order barring Toney from acting as an investment adviser for at least a year.
‘Fund investors relied on MMR and Toney to abide by their fiduciary duties and put the fund’s interests ahead of their own,’ says Marc J. Fagel, regional director of the SEC’s San Francisco office. ‘Instead, Toney engaged in trading activity which hid his poor performance.’
According to the SEC, MedCap Partners, a hedge fund run by Medcap Management and Toney, was suffering from dramatic losses and facing increasing redemptions from investors by September 2006.
Over the last four days of the month, Toney – through a separate fund that the firm managed – placed numerous buy orders for a thinly-traded over-the-counter stock in which MedCap Partners already was heavily invested. The buying pressure caused the stock price to more than quadruple, from USD0.85 to USD3.72.
The SEC alleges that because the stock represented over one-third of MedCap Partners’ holdings, the brief boost in its price inflated the fund’s reported value by USD29m, masking what would otherwise have been a 40 percent quarterly loss.
Immediately after the quarter ended, Toney reported to investors that the fund’s investments had begun to ‘bounce’ and that its performance was improving. He failed to disclose that this ‘bounce’ was almost entirely the result of his four-day purchasing spree.
Following Medcap Management’s brief buying activity, both the stock price and the fund’s asset value declined to their previous levels. However, according to the SEC, the firm charged fees to the fund based on the inflated quarter-end asset value.
The commission found that Medcap Management and Toney breached their fiduciary duties to MedCap Partners and to the firm’s other fund by which the penny stock was acquired. The defendants have agreed to cease and desist from violating the antifraud provisions of the Investment Advisers Act of 1940.
Medcap Management also disgorge the higher management fees it received due to the inflated fund asset value, plus interest, an amount totaling USD70,633.69, and receive an SEC censure. Toney has agreed to a bar from association with any investment adviser with the right to reapply after one year, and to pay a USD100,000 penalty.
