Structured Alpha Manager Settlement Offers Due Diligence Lessons

Earlier this month, former Allianz Global Investors U.S. fund manager Gregoire Tournant was sentenced following his guilty plea for fraudulently inflating the value of several funds that ultimately collapsed. Tournant pled guilty in June to two counts of investment adviser fraud. Each count carried a maximum sentence of five years in prison.

Tournant will spend 18 months in home confinement, followed by an additional three years’ probation, and will pay a previously ordered forfeiture of approximately $17.5 million. The unusual arrangement, called a “just sentence” by his attorneys, keeps Tournant out of jail.

“The government asked the judge to find that our client caused a $3 billion loss, and she agreed with us that the loss caused was zero,” says Daniel R. Alonso, a partner in law firm Orrick, Herrington & Sutcliffe LLP and one of the attorneys that handled Tournant’s defense. Seth Levine and Alison Bonelli from Levine Lee LLP served as co-counsel. “Mr. Tournant’s criminality in this case was much more limited than the government argued. That’s rare—but it was correct. The sentence is an example of why it is important to have independent judges review the facts of the case and come to a determination.”

The sentencing was the final step in a case that also saw Allianz pay billions of dollars in fines and raised significant questions about institutional due diligence.

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Questionable Internal Controls

Between 2014 and 2020, Tournant was the CIO of a set of private funds at Allianz known as the Structured Alpha funds. The funds were marketed as an options strategy that would preserve capital during a market downturn. These funds were marketed largely to institutional investors, including pension funds. At their peak, the funds had approximately $11 billion in assets under management.

In 2020, cracks started to show. Several investors—including the Arkansas Teacher Retirement System, the Blue Cross Blue Shield Association National Employee Benefits Commission and the City of Milwaukee Employees’ Retirement System—filed suit, arguing that the strategy was risky and led to higher losses than anticipated.

According to federal case filings, the Department of Justice alleged that to conceal the real risk-return profile of the funds, Tournant and other portfolio managers provided investors with altered documents to hide the true riskiness of the funds’ investments, including that the investments were not sufficiently hedged against risks associated with a market crash. In March 2020, following the onset of market declines brought on by the COVID-19 pandemic, the Structured Alpha funds lost in excess of $7 billion in market value, including more than $3.2 billion in principal; faced margin calls and redemption requests; and were ultimately shut down.

On May 17, 2022, AllianzGI pled guilty to securities fraud in connection with the funds and later was sentenced to pay a criminal fine of approximately $2.3 billion, forfeit approximately $463 million and pay more than $3 billion in restitution to investors.

Lisa Silverman, senior managing director at diligence consultant K2 Integrity, says cases like this raise questions about internal controls. While it is normal for large firms like AllianzGI to bring in small teams that have unique strategies, firms need to have a process in place to monitor performance—and business operations—throughout the life of the relationship.

“Investors need to be asking if there are controls in place,” Silverman says. “They should also be asking for evidence that the controls are actually being followed. It’s not clear that they were in this case.”

Crafting a Strong Process

Investors are often limited in how they can review the diligence efforts of investment funds, either by budget or time constraints. Over time, that has led to a clear preference among investors for large, brand-name asset managers, based on the perception that their status offers lower risk. But, Silverman says, there is a growing risk that fraud and other issues could arise as large asset managers focus on acquiring small teams as a growth strategy.

“There is a long history here,” she says. “Any time an asset manager is bringing in a team, there is going to be an integration process. That means the asset manager has to look at how they are doing that—are there loopholes that can be exploited? What’s the risk that something gets missed when they are evaluating a team?”

From an investor standpoint, that means it is important for the due diligence process to encompass both the asset management firm and individual managers themselves. Tournant, for example, ran his own options strategy before joining Allianz. Silverman says she would have looked closely at that business and its results, in addition to whatever diligence was done on the Structured Alpha funds themselves, to gain insights about Tournant and his team.

“Any diligence process is going to come with trade-offs,” Silverman says. “You can look at what other investors have done if you’re going into the same fund, but it may not tell the whole story. Ultimately, investors have to come up with a diligence strategy that they feel comfortable with and maintain it over the life of the relationship to ensure that nothing has changed. Due diligence can be annoying and expensive, but it’s like a trip to the dentist: No one wants to do it, but it’s how you catch things before they become a big problem.”

Tags: Alison Bonelli, Allianz Global Investors, Daniel R. Alonso, Due Diligence, Governance, Gregoire Tournant, Herrington & Sutcliffe LLP, Internal Controls, K2 Integrity, Levine Lee LLP, Lisa Silverman, Orrick, Seth Levine, Structured Alpha

Ken Leech, former CIO of fixed-income manager Western Asset Management Co., has pleaded not guilty to charges that he helped certain clients profit from favorable trades at the expense of other clients, who suffered losses.

Leech was charged with fraud by the Securities and Exchange Commission and the Department of Justice in November. He pleaded not guilty to all charges at a hearing in U.S. District Court for the Southern District of New York on Monday. Earlier, he was granted $10 million bail and was released on bond, according to a spokesperson for the Southern District of New York.

According to the SEC complaint, between January 2021 and October 2023, Leech assigned winning trades to favored clients, netting a total of $600 million for clients. Unfavored clients lost $600 million, according to the complaint.

Leech, 70, of Pasadena, California, was charged with one count of investment adviser fraud and one count of securities fraud. Both charges carry a maximum penalty of 20 years in prison. Additionally, Leech was charged with one count of commodity trading adviser fraud and one count of commodities fraud, each carrying a maximum sentence of 10 years in prison, and one count of making false statements, carrying a maximum sentence of five years.

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Attorneys for Leech had no further comment on Leech’s plea. In November, Jonathan Sack, of Morvillo Abramowitz Grand Iason & Anello P.C., counsel for Leech, said in a statement the allegations were unfounded and that Leech would defend himself vigorously.

Leech is accused of placing trades with brokers and then waiting to allocate them across portfolios. Leech was able to observe price movements with the delay and then allocate winning trades to favored portfolios.

“The statistical probability that this pattern occurred by random chance is less than one in one trillion,” according to the SEC complaint.

Leech was a portfolio manager for numerous portfolios, including the “Macro Opportunities” strategy and the WAMCO “Core” and “Core Plus” strategies. Leech is accused of making favorable trades to the Macro Opportunities strategy, while unfavorable trades were made to the Core strategies.

At certain times during the relevant period, Core had more than $44 billion in assets under management, while Core Plus had more than $122 billion in AUM. As of June 30, the strategies had $31.1 billion and $66.8 billion, respectively, in AUM, according to the SEC claim.

Macro Opportunities had more than $13 billion in AUM at one point. Despite being a smaller portfolio, Macro Opportunities had higher management and performance fees. Core and Core Plus clients paid between five and 45 basis points of portfolio market value in fees, while Macro Opps clients paid between 40 and 115 bps.

“Because of this difference in fee structures, each dollar of AUM in Macro Opps portfolios could generate approximately four times as much revenue for Western Asset as each dollar in Core and Core Plus portfolios,” the SEC complaint stated.

“Leech routinely waited hours after making his trades—often until late in the day—to make his allocations, allowing him to observe how his trades had performed before deciding where to allocate them. Between 2021 and October 2023, Leech used that ability to see how the market moved to support Macro Opps by awarding it better performing trading and hiding worse performing trades in the Core Strategies,” a statement from the Department of Justice said.

Macro Opportunities was not without losses, however. Some of the losing investments in Macro Opportunities included Russian debt, which was nearly wiped out in early 2022 following the invasion of Ukraine, and Credit Suisse debt, which was completely wiped out when the bank collapsed in 2023. Over the 2021 to 2023 period during which Leech is accused of running the scheme, assets under management in the Macro Opportunities strategy fell by 80%, dropping to less than $3 billion, according to the SEC complaint.

To mitigate losses in the Macro Opportunities strategy, Leech told clients to stay invested in the strategy by “claiming Macro Opps typically recovered quickly after suffering losses,” the complaint stated. As of October 29, the Macro Opps strategy ceased operations and was liquidated.

As a result of the allegations, institutional clients, including the Illinois Municipal Retirement Fund, the Chicago Teachers’ Pension Fund and the Kern County Employees’ Retirement Association, terminated WAMCO as a manager. WAMCO, a subsidiary of Franklin Templeton, this month appointed Thomas Gahan as the firm’s new CEO. Gahan came from Benefit Street Partners, another subsidiary of Franklin Templeton.