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News February 1, 2016 Issue

Fee Disclosure Issues Cause Problems for Futures Fund Adviser

Improper fee disclosure has long been a red flag to SEC examiners and investigators. The problem is magnified when the failure to disclose results in overcharging clients. If the disclosure is corrected but refunds are not made to the clients, expect the agency to come calling.

Consider Equinox Fund Management, a Denver-based alternative fund manager that specializes in managed futures. The firm, which manages approximately $268 million in assets as a commodity pool operator, on January 19 reached a $6.4 million settlement with the agency over allegations that it both overcharged management fees and misled investors about how it valued assets – and then allegedly failed to refund the overcharged fees to its client.

Equinox, according to the SEC, "calculated management fees contrary to the method described in registration statements for a managed futures fund called The Frontier Fund, and the firm also deviated from its disclosed valuation methodology for some [Frontier Fund] holdings."

"Fund managers can’t tell investors one thing and do another when assessing fees and valuing assets," said Division of Enforcement Asset Management Unit co-chief Marshall Sprung. "Equinox’s misleading disclosures gave investors a distorted picture of how the firm determined compensation and valued significant fund holdings."

Equinox, as part of the settlement, agreed to pay $5.4 million in disgorgement, plus $600,000 in interest, as well as a civil money penalty of $400,000.

Disclosure and refund issues

Equinox ran into its fee miscalculation problems when it based its management fees on the notional trading value of the assets (total amount invested including leverage), rather than on the net asset value of each Frontier Fund series, as disclosed in the fund’s registration statements from 2004 through March 2011, according to the SEC. The result, the agency said, was that the Frontier Fund was charged $5.4 million more than it would have been if NAV had been used.

"In the managed futures business, it’s common to base fees on notional trading value," said Sidley Austin partner Jim Munsell. "But the disclosure must be clear."

Equinox discovered the problem when the Frontier Fund’s independent auditors questioned why there was a difference between the notional trading value used in practice and the NAV described in the fund’s disclosure statement, according to the administrative order instituting the settlement. Here’s the rub: While Equinox then modified the Frontier Fund’s Form 10-K and its registration statement appropriately to disclose that it charged management fees on notional assets, it did not refund to the fund the additional management fees it had collected – $5.4 million – prior to the modification of its documents, the agency said.

"Simply stated, when the auditor advised the fund manager of this issue, how could it not reach the required end point to make the client whole? The SEC possibly would have had a different approach if it had done that, potentially saving the firm a large expense and reputational exposure," said Eaton & Van Winkle partner Paul Lieberman. "Why wouldn’t you ask your general counsel or call outside counsel to get their opinion on the right thing to do in this situation?"

"If you uncover the problem, it’s not enough to fix the disclosure, you have to remediate the harm," said Munsell. "By changing the disclosure, they put up a big red flag that said, ‘examine me,’" but they did not have a plan to remediate."

Counterparties, options and more

In addition to the fee miscalculation problem, the SEC made three other allegations:

  • Counterparty corroboration not used. The Frontier Fund, in its Form 10-K for 2010 and in its Forms 10-Q for the first and second quarters of 2011, said that its methodology for valuation of certain derivatives was corroborated by weekly counterparty settlement values, when it was not, the agency said. "Equinox received certain information during the timeframe showing that its valuation of certain options was materially higher than the counterparty’s indicative settlement valuations."
  • Option not transferred. According to the agency, the Frontier Fund’s Form 10-Q for the third quarter of 2011 said that an option had been transferred between two series in accordance with the fund’s valuation policies, "when, in reality, the option had been transferred using a different valuation methodology than substantially identical options held by other [Frontier Fund] series."
  • Option termination not disclosed. The Frontier Fund its Form 10-Q for the second quarter of 2011 failed to disclose as a material subsequent event the series’ early termination of an option at a valuation of $3.7 million, materially different from the more than $5 million valuation that had been recorded for that option, the SEC said. The terminated option constituted the series’ largest investment.

"It is interesting to note that the SEC’s 2016 exam priorities emphasize conflicts of interest, risk management, supervision and compliance controls," said Lieberman. "These are not new topics or matters that are unknown to investment advisers and fund managers. This is basic books and records, accounting and math."


Equinox, according to the SEC, willfully violated Section 17(a)(2) of the Securities Act, which prohibits making untrue statements of material fact, and Section (a)(3), which prohibits fraud. The firm was also charged with causing the Frontier Fund to violate Section 13(a) of the Exchange Act and its Rules 12b-20, 13a-1 and 13a-13, which require issuers to file non-misleading reports with the Commission. An attorney representing the firm did not respond to a request for comment.