(Article from Registered Funds Regulatory Update, January 2023)
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Background
In September 2022, separate settlements were reached with the SEC and investors in a class action lawsuit in connection with a fraudulent valuation scheme involving Infinity Q Diversified Alpha Mutual Fund, a series fund of Trust for Advised Portfolios, a registered investment company, and its parallel hedge fund (collectively, the “Funds”) both of which were managed by Infinity Q Capital Management LLC (“Infinity Q”). According to the settlements, from February 2017 through February 2021, James Velissaris, founder and former chief investment officer of Infinity Q, manipulated valuation models from third-party pricing services and altered inputs to hide the Funds’ poor performance. Velissaris manipulated the valuations by: (i) altering the computer code in the pricing service valuation models; (ii) knowingly entering incorrect inputs into the pricing service; (iii) selecting valuation models that he knew could not accurately value the relevant Fund positions; and (iv) knowingly cherry-picking valuation inputs. Velissaris’ actions resulted in the overvaluation of the Funds by over $1 billion by September 2020.
On February 19, 2021, redemptions in the Funds were halted and the Funds were subsequently liquidated with investors suffering massive losses. Thereafter, several Fund investors brought a class action lawsuit against the Funds, directors, officers and several service providers. On February 17, 2022, the United States Attorney’s Office for the Southern District of New York charged Velissaris with securities fraud, making false statements to auditors, and obstruction of justice. On the same day, the SEC and CFTC commenced civil actions against Velissaris for violating the anti-fraud provisions of the federal securities laws. On November 21, 2022, Velissaris pled guilty to the securities fraud charges brought by the Southern District of New York. According to the plea agreement, Velissaris faces 19 ½ to 20 years in prison and a fine ranging from $50,000 to $5 million under the advisory sentencing guidelines. He has agreed to forfeit $22 million and will be sentenced in March 2023. On September 30, 2022, the SEC settled charges against Scott Lindell, Infinity Q’s former Chief Risk Officer, Head of Operations, and Chief Compliance Officer. Velissaris continues to face charges brought by the SEC and CFTC.
CCO Settlement
The SEC’s Complaint against the Funds’ CCO, Lindell, alleged that he was aware of Velissaris’ fraudulent valuation scheme and failed to investigate the independence of the pricing services. It was also noted that the CCO participated in the scheme by misrepresenting to investors and directors that the pricing services were “independent” of Infinity Q. The SEC found the CCO willfully made misstatements on Infinity Q’s Form ADV filings, assisted Velissaris in submitting misleading documents to the Staff, and misled Infinity Q’s auditor.
The CCO agreed to settle the charges. The settlement, which is subject to court approval, permanently enjoins the CCO from violating the federal securities laws and includes disgorgement, prejudgment interest, and civil money penalties in amounts to be decided by the Court.
Class Action Settlement
In connection with this valuation scheme, the Funds and their directors, officers, and service providers entered into a Stipulation of Settlement with Fund investors. The Defendants include the Funds, Infinity Q, the Funds’ directors and officers, the Funds’ distributor, the Funds’ independent accounting firm, and the Funds’ transfer agent.
The lawsuit alleged that the Defendants made materially false and misleading statements and failed to disclose material information on the valuation process for the Funds. The lawsuit also alleged that the Defendants did not adhere to the Funds’ valuation procedures and tampered with third-party pricing models, which led to the overstated valuation of fund assets.
On September 7, 2022, the Defendants submitted a proposed stipulation of settlement to the U.S. District Court in the Eastern District of New York. Pursuant to the Class Action Settlement, the Defendants have agreed to a cash settlement of $39,750,000 which can increase up to $48,000,000 based on the occurrence of certain contingencies (the “Settlement Fund”). Each Defendant has agreed to pay the following amounts: (i) $4,600,000 by the Funds and Fund officers and directors; (ii) $2,500,000 by the distributor; (iii) $16,750,000 by the auditor; (iv) $250,000 by the transfer agent; and (v) $15,650,000 by Infinity Q. Infinity Q also assigned its rights to up to $3,000,000 of insurance proceeds to the Settlement Fund.
Appointment of a Special Master
On November 10, 2022, the SEC filed a settled action against the Infinity Q Diversified Alpha Mutual Fund. As part of its complaint, the SEC is seeking the appointment of a special master over the Fund to oversee the distribution of remaining assets to harmed investors. The settlement, pursuant to which the Fund is permanently enjoined from violating Rule 22c-1 under the 1940 Act, and the appointment of a special master are subject to court approval.
Securities and Exchange Commission v. Scott Lindell, 1:22-cv-08368 (S.D.N.Y. Filed September 30, 2022), available at: https://www.sec.gov/litigation/complaints/2022/comp25542.pdf; In re Infinity Q Diversified Alpha Fund and Infinity Q Volatility Alpha Fund, L.P. Securities Litigation, No. 1:21-cv-1047-FB-MMH (E.D.N.Y.); Securities and Exchange Commission v. Infinity Q Diversified Alpha Fund, 1:22-cv-09608 (S.D.N.Y. Filed November 10, 2022), available at: https://www.sec.gov/litigation/complaints/2022/comp25575.pdf; United States of America v. James Velissaris, 1:22-cr-00105 (S.D.N.Y. Nov. 21, 2022).