Risky Business Leads to $1 Billion Trading Loss, Charges for Fund Execs

The SEC has filed a civil action against two investment firms and their portfolio managers for allegedly misleading investors and the board of a fund they advised about a risky trading strategy that led to the loss of more than $1 billion over two trading days.

According to the SEC’s complaint, LJM Funds Management and LJM Partners, and their portfolio managers Anthony Caine and Anish Parvataneni, adopted a short volatility trading strategy that used margin to sell out-of-the-money put and call options on S&P 500 futures contracts. The option writing strategy was similar to selling insurance in that it “carried risks that were remote but extreme.”

This concerned investors in the funds about how LJM managed risk and wanted to know how much of their investment they might lose during an extreme market event. In an attempt to assuage the investors’ concerns, the firm and its portfolio managers “crafted an effective, yet false, marketing narrative which touted their purported ‘risk centric’ approach to investing and avowed their ‘managing principle’ was to maintain a consistent risk profile and consistent risk levels,” said the complaint.

For example, the managers claimed they stress tested the portfolios against specific historical scenarios to estimate worst-case daily losses, and that based on those stress tests, the estimated worst-case scenario was a daily loss of 20% for the LJM Preservation & Growth Fund, and 30% to 35% for several private investment funds.

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“All of these statements were false,” said the complaint. “Although LJM automatically generated historical scenario stress tests on every trading day, defendants did not use those stress tests to estimate worst-case losses to the portfolios during extreme market events.”

The SEC alleges that to arrive at the 20% estimated worst-case daily loss for the Preservation & Growth Fund, the managers merely took the fund’s worst performance on a single day, which was approximately 9%, doubled it, and then rounded up. The regulator also accused the firm of deliberately pursuing riskier investments to meet their targeted returns, while reaping the benefits.

“During the period when LJM misled investors concerning risk, money flowed into the funds,” said the complaint. “LJM’s assets under management grew from approximately $450 million in February 2016 to approximately $1.3 billion in February 2018.”

And then in February 2018, the financial markets suffered a large spike in volatility over two trading days, causing the LJM-managed funds to lose more than 80%, or over $1 billion in that time.

The complaint charges the firm and the portfolio managers with violating the antifraud provisions of the federal securities laws and seeks permanent injunctions, disgorgement with prejudgment interest, and civil penalties. The SEC also settled administrative and cease-and-desist proceedings against LJM’s Chief Risk Officer Arjuna Ariathurai. Ariathurai agreed, without admitting or denying the regulator’s findings, to an associational bar with a right to apply for reentry after three years, disgorgement, prejudgment interest of over $97,000, and a civil penalty of $150,000.

“This case demonstrates the critical importance of fund advisers being truthful and transparent with investors about how they manage risk,” Daniel Michael, chief of the SEC Enforcement Division’s Complex Financial Instruments Unit, said in a statement. “The defendants’ alleged actions exposed investors to far greater risk of loss than they expected.”

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Tags: Anish Parvataneni, Anthony Caine, Arjuna Ariathurai, Fraud, LJM Funds Management, LJM Partners, Risk, SEC, Securities and Exchange Commission, Volatility

Sticking around and backing dissident board candidates worked. Instead of divesting from Exxon Mobil, the US’s biggest oil company, the nation’s three largest public pension funds pursued a successful strategy of advocating for change, and they just helped elect a pair of outside directors. Expect more of this tack against fossil fuel outfits.

Running counter to the trend of pension programs dumping fossil fuel stocks, these giant retirement systems—the California Public Employees’ Retirement System (CalPERS), the California State Teachers’ Retirement System (CalSTRS), and the New York State Common Retirement Fund—believe that, in most cases, working from within is the better way to promote change.

They were key players in electing the two outside directors (a third is still up in the air as proxy ballots are counted), along with huge asset managers BlackRock and Vanguard, plus other pension entities such as the Church of England’s program.

Chris Ailman, the CIO of CalSTRS, has been particularly vocal in his advocacy of staying engaged with controversial companies, particularly fossil fuel ones. He reasons that being a big shareholder allows the $300 billion fund to agitate for change. “Divesting and just dumping your shares is equivalent to disappearing and ignoring a problem and hoping it goes away. Or somebody else steps up to deal with it,” he has said.

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In the same spirit, CalPERS notes that, since 2013, the $464 billion fund has pressured 100 companies in the Russell 1000 index to disclose energy and water use management. And 30 companies replied that they would do so.

Meanwhile, the $248 billion New York Common fund has employed a sector-by-sector approach to get fossil fuel companies to commit to net-zero carbon emissions by 2050. Oil sands firms were most recently under its microscope. In April, the pension fund announced that, after a review, it would sell shares in seven such companies—and stay with the rest, which it believes will move to carbon-free status.

For Exxon, though, the transformation the funds seek still is a work in progress. “Exxon Mobil shareholders chose real action to address the climate crisis over business as usual in the fossil fuel industry,” said New York State Comptroller Thomas DiNapoli, who oversees the pension system, in a statement.

Leading the insurgency at Exxon was a hedge fund, called Engine No. 1, which complained that the oil colossus lacks a viable strategy for dealing with the existential threat of climate change and has displayed poor corporate governance.

CalSTRS in particular has been outspoken in its dismay over Exxon’s financial performance. Over the past 10 years, the company’s debt has expanded ninefold, and last fall it wrote off assets worth as much as $20 billion, owing to problems at an acquisition, XTO Energy. As crude prices have come back lately, Exxon stock has rebounded to $60, up from a recent low of $34 last summer. Still, it is way short of its $101 peak in late 2013.

On the subject of divesting versus staying invested, the funds have different views. Last July, New York Common divested from coal, for example. On non-energy related companies, the decision seems easier to tilt toward unloading shares. Perhaps because it believes cigarette and firearms companies can’t be made over into something more to its liking, CalPERS long ago dumped shares in those industries.

The Exxon proxy fight was very expensive, and CEO Darren Woods fought against the four-candidate activist slate. A preliminary tally showed that at least two of them had won seats: Gregory Goff, former chief executive at petroleum refining and marketing company Andeavor, and Kaisa Hietala, a former executive vice president in renewable products at petroleum refining firm Neste.

After that result became public, Woods issued a statement saying, “We welcome all of our new directors and look forward to working with them constructively.” How effective the newcomers will be as a minority on the 12-member board remains to be seen.

Exxon has resisted past attempts to get it to change its leadership and policies. The pandemic, however, seems to have made the company more open to change, in a limited sense. Its 2020 loss due to the world’s economic lockdown, which sliced oil demand, had built pressure for the oil major to be somewhat more accommodative to criticism.

Since December, Exxon has expanded its board, promised to boost low-carbon initiatives, and stated it would lower oilfield greenhouse-gas emissions.