The U.S. Securities and Exchange Commission (SEC) has brought its first enforcement action in defense of a whistleblower, charging a hedge fund advisor with carrying out improper trading activity, and for retaliating against an employee with reported the questionable trading activity to the SEC.
The SEC said Monday that it has charged an Albany, N.Y.-based hedge fund advisory firm, Paradigm Capital Management, and the firm’s owner, Candace King Weir, with engaging in prohibited principal transactions, and then retaliating against the employee who reported the trading activity to the SEC. They agreed to pay US$2.2 million to settle the charges, without admitting or denying the findings in the SEC’s order against them. The payout includes disgorgement of $1.7 million for distribution to current and former investors in the hedge fund, prejudgment interest of $181,771, and a penalty of $300,000. The firm also agreed to retain an independent compliance consultant.
According to the SEC’s order, Weir conducted transactions between Paradigm and a broker-dealer that she also owns while trading on behalf of a hedge fund client. Given that this sort of trading creates a possible conflict between the interests of the adviser and the client, advisers are required to disclose that they are participating on both sides of the trade and must obtain the client’s consent.
The SEC says that the firm attempted to satisfy the written disclosure and consent requirements by establishing a conflicts committee to review and approve each of the principal transactions on behalf of the hedge fund. However, it found that the committee was, itself, conflicted, as it consisted of two people that essentially reported to Weir. Because the conflicts committee was not independent, “Paradigm failed to provide effective written disclosure to its hedge fund client and failed effectively to obtain the hedge fund’s consent prior to the completion of each principal transaction,” the SEC order says.
“Paradigm’s use of a conflicted committee denied its hedge fund client the effective disclosure and consent to which it was entitled,” said Julie Riewe, co-chief of the SEC enforcement division’s asset management unit. “Advisers to pooled investment vehicles need to ensure that any mechanism developed to address conflicts in principal transactions actually mitigates those conflicts.”
The SEC also says that after Paradigm discovered that the firm’s head trader had reported potential misconduct to the regulator, it “engaged in a series of retaliatory actions that ultimately resulted in the head trader’s resignation.” It says the firm removed him from his position as head trader, tasked him with investigating the very conduct he reported to the SEC, changed his job function from head trader to a full-time compliance assistant, stripped him of his supervisory responsibilities, and otherwise marginalized him.
“For whistleblowers to come forward, they must feel assured that they’re protected from retaliation and the law is on their side should it occur,” said Sean McKessy, chief of the SEC’s Office of the Whistleblower. “We will continue to exercise our anti-retaliation authority in these and other types of situations where a whistleblower is wrongfully targeted for doing the right thing and reporting a possible securities law violation.”
This is the first time the SEC has filed a case under its new authority to bring anti-retaliation enforcement actions. “Paradigm retaliated against an employee who reported potentially illegal activity to the SEC,” said Andrew Ceresney, director of the SEC enforcement division. “Those who might consider punishing whistleblowers should realize that such retaliation, in any form, is unacceptable.”