The US Securities and Exchange Commission has ordered Northern Trust Hedge Fund Services LLC and its Cayman fund administration subsidiary Northern Trust Global Fund Services Cayman Limited to pay US$167,629 for regulatory breaches in their role as the administrators for the LR Global Frontier master and feeder funds from January 2016 to August 2017.
The breaches related to an alleged fraud by Donald LaGuardia Jr., who controlled L-R Managers LLC, the investment advisor of the LR Global Frontier funds.
The SEC alleges LaGuardia misappropriated approximately $2.6 million from investors and then concealed part of those funds through fraudulent accounting.
According to an SEC complaint filed in June 2019, LaGuardia Jr. misappropriated investor money from private funds advised by L-R Managers and from subscriptions intended to be invested in one of the funds. LaGuardia then allegedly concealed part of this activity through a sham receivable and promissory note and other accounting devices to inflate the capital account balances and returns reported to investors.
L-R Managers filed for bankruptcy in June 2017.
The SEC issued an administrative order instituting cease-and-desist proceedings against Northern Trust Hedge Fund Services on 18 Sept. The order accepted a settlement, which included the civil penalty, offered by Northern Trust in anticipation of the proceedings.
The order stated that before starting to provide fund administration services, Northern Trust personnel “failed to adequately escalate concerns they identified regarding LaGuardia and L-R Managers”. This included a civil suit against the manager alleging fraud that was identified during the due diligence process.
During the engagement, the SEC said, Northern Trust permitted the advisers to withdraw approximately $211,000 from the funds without support and followed the adviser’s instruction to account for the withdrawals as part of a receivable “due from” L-R Managers to the funds.
When calculating the funds’ net asset value (NAV), Northern Trust staff, at the direction of the advisers, “accounted for another receivable, the promissory note and the ‘true-up’ as assets of the funds despite information that should have caused them to question whether L-R Managers would be able to repay these amounts”, the SEC administrative order said.
The true-up referred to a hypothetical performance gain that reflected the estimated performance of previous investments of the funds, which had been liquidated and the proceeds were not reinvested. The manager purportedly wanted to “reimburse” the investors for any gains they would have received had the investments been retained, the order noted. This inflated the NAV reported to the funds’ investors by $347,000 as of 30 Sept. 2016.
The SEC added that Northern Trust also did not obtain sufficient pricing support, as set out in the valuation guidance provided in its professional services agreement, for a significant holding of the funds that was an illiquid investment in a private company affiliated with the manager.
However, the commission acknowledged that Northern Trust took certain measures to remediate the situation. After the advisers requested to write off the promissory note, the fund administrator undertook a review and in August 2017 contacted the SEC to report “concerns about the conduct of the advisers, including with respect to fund accounting and valuation”.
In addition, Northern Trust made several changes to its fund administration policies, procedures and controls.