(Bloomberg) -- Deer Park Road Management, the $2.2 billion hedge fund firm founded by Michael Craig-Scheckman, is being investigated by U.S. regulators over whether the hedge fund violated securities laws when valuing infrequently traded bonds, according to people familiar with the matter.
The Securities and Exchange Commission is questioning why the fund priced certain debt positions below market norms, said one of the people, who asked not to be identified because the probe isn't public. The inquiry focuses on the pricing of hard-to-value residential mortgage-backed securities, some of which can go months without trading.
Deer Park Road, based in Steamboat Springs, Colorado, hasn't been accused of any wrongdoing and investigations don't necessarily lead to enforcement actions.
“Deer Park makes every effort to price its portfolio carefully and properly,” Greg Marose, an external spokesman for the asset manager, said in a statement. “The firm has cooperated with the SEC staff in answering questions about whether certain illiquid bonds within private fund portfolios may have been undervalued years ago. Our commitment to running an ethical, trustworthy and well-governed firm is second to none.”
Judy Burns, an SEC spokeswoman, declined to comment.
Opaque Markets
Wall Street's main regulator has been looking into the opaque markets for asset-backed securities since the financial crisis, uncovering a wide swath of bad behavior from lying salesmen to bogus quotes from brokers.
As part of the sweep, the agency is investigating a counterintuitive issue: fund managers undervaluing their portfolios. Keri Findley, a former Third Point partner, is also being probed by the SEC for a similar practice, Bloomberg News reported in October.
An attorney representing Findley, who hasn't been accused of any misconduct, had no immediate comment, while the SEC's Burns also declined to comment on the ex-Third Point partner.
Undervaluing Bonds
It isn't clear why Deer Park Road may have undervalued any positions.
Marking down bonds could lower the value of an entire hedge fund, which would mean less money for fund clients who redeem their investments. The practice could also allow a manager to inappropriately smooth returns or realize a bigger year-end payout. A trader might cause a bond's valuation to be low-balled at the beginning of the year, and then increased later to offset losses on other holdings in his or her portfolio. By year-end, the proper price would be used to calculate fees and bonuses.
Craig-Scheckman, who pursued a doctorate in X-ray astrophysics in the 1970s before deciding to turn his talents to finance, founded Deer Park Road in 2003. The firm is known for its wildly profitable bets on deeply discounted mortgage- and asset-backed securities in the wake of the 2008 financial crisis.
Its $1.7 billion STS Master Fund returned a cumulative 688 percent from its inception in May 2008 through the end of 2017, according to a performance document viewed by Bloomberg -- almost five times the gain of the S&P 500 Index. The fund reported a monthly loss just five times and has never had a losing year. Still, its outsized returns of as much as 49 percent in 2009 have moderated. The fund made about 9 percent in both 2015 and 2016, and about 20 percent in 2017.
Mortgage bonds and other asset-backed debt have been a target for the SEC because such securities aren't traded on exchanges. To value bonds, hedge funds typically rely on estimates from brokers and quotes from third parties, a process regulators argue is ripe for abuse.
To contact the reporters on this story: Simone Foxman in New York at sfoxman4@bloomberg.net, Matt Robinson in New York at mrobinson55@bloomberg.net.
To contact the editors responsible for this story: Margaret Collins at mcollins45@bloomberg.net, Jesse Westbrook at jwestbrook1@bloomberg.net, Josh Friedman
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