Mutual Funds Profit Detoured into Manager’s Pocket

Jack Humphrey, Regulatory journalist
March 02, 2011 /

Lawrence Goldfarb from Larkspur, California may have diverted the mutual funds entrusted to him by his investors using “side pocket” but the Securities and Exchange Commission gives no lenient treatment to this kind of activity as hedge fund managers “need to honor their obligations to investors,” said enforcement co-chief Robert Kaplan.

The SEC has filed charges before the federal district court in San Francisco against Goldfarb and company, Baystar Capital Management, after investigators Erin Schneider and Robert Leach of the San Francisco Regional Office found that he “side-pocketed” the proceeds of the mutual funds worth more than $12 million owed to investors.

Side-pocketing is maintaining an account that separates illiquid investments from the rest of the funds. Side-pockets provide little access to investors.

In 2006, the mutual funds have turned in proceeds which Goldfarb allegedly hid from investors like Baystar Capital II and instead used for his other entities such as a real estate venture and a San Francisco record company. These transactions breached the mutual funds agreement.

For years, Goldfarb was able to hide the illegal activity from investors by giving them sham statements of accounts professing that the side-pocket had not gained profits, meaning “side pocket investment had not yet distributed any profits to the fund.”

According to the SEC, mutual funds in side-pocket investments can only be withdrawn once “the underlying position has been sold or liquidated” to limit any act of redeeming disproportionate share of the fund’s liquid assets in an earlier period.

Goldfarb settled SEC’s charges by agreeing to pay $12,112,416 in disgorgement and $1,967,371 in prejudgment interest to be given to mutual funds investors injured by the scheme.


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