Hedge fund manager Otto Spork will defend the legitimacy of the Icelandic glacier investments made by his once high-flying but now frozen hedge funds at an Ontario Securities Commission hearing on Mar. 16.

In a statement of allegations, the OSC has accused Toronto-based Sextant Capital Management Inc. and Spork, its founder and former president, of a number of offences. These include self-dealing and exaggeration of asset values, notably the value of two glacier companies that were to become sources of bottled water. The OSC also says custodians for Sextant’s funds are unable to account for more than $90 million in investor assets. Spork, who once operated a dental practice in addition to his financial activities, now resides in Iceland.

Spork’s lawyer, Joseph Groia, president of Toronto-based law firm Groia & Co., says the OSC “completely misunderstands” the nature of the businesses in which Sextant is investing, and the allegation that $90 million is unaccounted for is “misguided and flat-out wrong.”

Any analysis of the books, Groia says, should be based on how much money was originally invested rather than the market value of Sextant’s investments, and the company can account for the majority of funds invested. The OSC has also overlooked amounts paid in fees and expenses, he says.

“We are trying to co-operate with the OSC, but it is a difficult challenge,” Groia says. “OSC staff does not seem to want to talk in a reasonable way.”

The OSC’s statement alleges that, Spork, his daughter Natalie Spork, who is currently listed as Sextant’s president, and Sextant’s chief compliance officer, Robert Levack, inflated the returns of Sextant funds by posting artificially high values for investments in two glacier companies. The OSC calls Spork the “ultimate driving force” behind Sextant Strategic Opportunities Hedge Fund, units of which were sold in Canada, and two offshore Sex-tant funds sold to non-Canadian inves-tors. The OSC froze Sextant Strategic Op-portunities’ assets at $53 million in December.

The OSC alleges that about 5% of that fund’s assets were invested in a portfolio of stocks, bonds and futures contracts, and the remaining 95% was invested in two private Luxembourg-based companies: Iceland Glacier Products and Iceland Global Water 2 Partners SCA. These companies purportedly own rights to glaciers in Iceland and intend to use those rights to develop and sell bottled water. But, the OSC statement says, neither has earned any revenue and “there are no indications they will do so in the immediate future.” According to the OSC, the glacier companies are owned almost entirely by Sextant funds and Spork.

Despite a lack of immediate financial prospects, IGP’s value appears to have increased by 984% since Sextant invested, the OSC alleges. This was a major contributor to the 730% total increase in the Canadian Sextant fund during the period since its inception in February 2006 through November 2008. There are no third-party valuation reports that support the material upward revisions in value, the OSC alleges. Nor has the fund filed audited financial statements for 2007.

As well, a Sextant affiliate was paid a management fee based on 2% of the fund’s assets plus 20% of its profits, and was, therefore, a beneficiary of the rapid rise in value of the fund, the OSC says. Significant performance fees in excess of $3 million have been paid based on the Sextant fund’s astronomical returns, the OSC statement alleges.

Sextant has issued a statement saying it will “vigorously defend” and prove wrong the OSC’s allegations. Meanwhile, Sextant Strategic Opportunities Hedge Fund is subject to a cease-trading order until March 17. The fund was originally sold only to accredited investors or those with a minimum of $150,000 to invest.

“The funds are showing a triple-digit return while the OSC is alleging an evaporation of asset value,” says Dan Hallett, president of Windsor, Ont.-based fund analysis firm Dan Hallett & Associates Inc. “If the OSC allegations of self-dealing are true, there is a huge conflict of interest.”

In a written statement responding to the OSC allegations, Spork says: “Sextant did not come to the party with its eyes closed, thus maintained a very conservative posture over the past three years, while gaining a 730% return for its inves-tors amidst the worst bear market in history, knowing full well that these returns would draw attention and be subject to scrutiny.”

@page_break@In Spork’s latest market letter, posted on Sextant Strategic Op-portunities Hedge Fund’s website, he wrote that the fund’s water investments have insulated it from the stock market turmoil: “Water is the most inelastic of all the commodities because it has no substitutes. We can go without food for an extended period of time, but can only do without water for three days. Because there is no substitute for water, its price can only go up as it becomes more scarce.”

The OSC statement also alleges that the Sextant fund invested in the two glacier companies knowing that Spork held a significant interest in them, which is a violation of the Securities Act. “Approximately 95% of the assets of the Sextant fund have been invested illegally,” the OSC statement says, “and in breach of protections in the Act against self-dealing by mutual funds.”

Groia counters that because the Sextant fund is a hedge fund sold by offering memorandum and is not a prospectus-sold mutual fund, it is not covered by the prohibitions against self-dealing that apply to regular mutual funds.

“There is no legal prohibition against self-dealing in hedge funds,” Groia says. “In fact, the offering memorandum contemplates situations of conflict, and lays out that investments may be made in companies in which the hedge fund manager has an interest. A lot of the opportunities available in hedge funds are due to existing relationships.”

Spork claims the investment in water will pay off handsomely in the future. “Water is fast becoming the world’s number one, most sought-after commodity and investment,” says his statement regarding the OSC allegations. “Many countries, including Canada, have blocked export of this vital commodity as water becomes scarcer worldwide. Sextant looks forward to the opportunity to present its case and counter these allegations in the proper venue.”

Al Kellett, a fund analyst with Morningstar Canada in Toronto, says the Sextant case is an example of why it’s important to assess a fund manager’s long-term track record. “When someone is doing well in an environment in which it’s difficult to do well,” Kellett says, “it should raise some questions about how those returns have been achieved.”

Hallett says the case points to the problems of transparency with hedge funds in particular, and to the higher risks posed by their ability to invest in unlisted companies without established market values. IE