Hedge fund manager fraud through PIPEs. Analysis of operational risk and the limits of law enforcement
| Pages | 636-645 |
| Published date | 02 July 2018 |
| DOI | https://doi.org/10.1108/JFC-04-2017-0032 |
| Date | 02 July 2018 |
| Author | Majed R. Muhtaseb |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial crime |
Hedge fund manager fraud
through PIPEs
Analysis of operational risk and the limits of
law enforcement
Majed R. Muhtaseb
California State Polytechnic University, Pomona, California, USA
Abstract
Purpose –The purpose of this paper is to draw lessons to investors from the conduct of a hedge fund
manager who according to the Securities and Exchange Commission (SEC) complaint made false and
misleading statements before and afteran auditor’s reports, misappropriated for personal benefit over $1m,
misappropriated clients’assets,failed to conduct due diligence on third-party buyer, instructedan employee
to mislead investors and satisfied some investors’redemptions with other investors’subscriptions (Ponzi
scheme) withoutdisclosing it to investors. Ironically, the scheme was unveiled by the economic crises and not
the investors, their advisersor third-party hedge fund vendors. Corey Ribotsky set up the investment adviser
NIR Group to manage four AJW Funds that investedin private equity in public companies in 1999. Through
manipulation of financial statements,he also managed to collect about $136m in management and incentive
fees over an eight-yearperiod. The SEC complaint alleged the AJW Funds’assets to be $876m in 2007,yet this
figure was not verified, and no assets were traced. Ribotsky did not pay any monies toSEC, as ordered by
court settlement, and hence the victims did not recover any of their monies. The SEC could not produce
criminal charges; hence, Ribotsky did notgo to jail. This case highlights sterility of law enforcementwhen
confrontedwith brazen fraud.
Findings –Investors fail to monitor hedge fund managers. Fraud was detected late and not through
investors. Fraud was unraveled by theeconomic crises of 2008. The SEC had sued the fund manager. The
fund manager consentedto making payment to the SEC but did not make any payments. The SEC couldnot
bring evidenceto criminally charge the fund manager.
Research limitations/implications –The findings based on the case study are valuable to investors
and hedge fund industrystakeholders. The findings are not based on an empiricalstudy.
Practical implications –Investors need to carefully vet all hedge fund managersbefore allocating and
funds and understandhow managers make money through the claimed strategy. Also, there are limitationsto
law enforcementeven with confronted with profoundfraud schemes.
Originality/value –The case was built up from public sources to benefit investorsconsidering making
allocationsto hedge fund managers. The public information about the case is of either legalisticor journalistic
in nature.
Keywords Operational risk, Fraud, Due diligence, Fund regulatory violations,
Hedge fund manager, Private investment in public companies
Paper type Research Paper
Introduction
Private investment in public equity (PIPE) is usually made by private accredited
institutional investorssuch as hedge funds and private equity funds. These investmentsare
oftentimes substantial and take the form of common stock, common stock with warrants,
convertible preferred stock and debt. Under certain conditions, PIPE investments can be
converted into a company’s common stock at a substantial discount from the market price.
The securities sale agreement requires the issuing company to file with the Securities and
JFC
25,3
636
Journalof Financial Crime
Vol.25 No. 3, 2018
pp. 636-645
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-04-2017-0032
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1359-0790.htm
To continue reading
Request your trial