On December 8, 2020, the Securities and Exchange Commission (“Commission”) entered a settled Order against previously registered investment adviser BlueCrest Capital Management Limited f/k/a BlueCrest Capital Management LLP (“BlueCrest”) for engaging in a course of conduct favoring its proprietary fund BSMA Limited (“BSMA”) at the expense of its flagship client fund BlueCrest Capital International (“BCI”) and failing to disclose related conflicts of interest. According to the Order, BlueCrest not only failed to disclose certain conflicts pertaining to BSMA, but took steps to actively conceal its existence.
BlueCrest’s Allocation of Traders to BSMA, RMT, and RMT’s Performance Issues
BlueCrest allocated BCI’s capital primarily to Rates and Relative Value strategies. In 2011, BlueCrest launched BSMA to trade the personal capital of its employees using the same strategies. BlueCrest transferred Rates and Relative Value traders from BCI to BSMA, despite the fact that, prior to BSMA’s launch, hypothetical back-testing showed such transfers could negatively impact BCI’s returns. During the relevant period, members of BlueCrest’s Executive Committee received periodic performance reports showing the majority of the best traders in terms of year-to-date profit and loss (“P&L”), returns, and returns on capital were assigned to BSMA. BlueCrest then replaced the BCI capital allocations of transferred traders with a semi-systematic trading system, a replication algorithm, called Rates Management Trading (“RMT”), which could not and did not perform as well as the live traders. The Executive Committee, comprised of BlueCrest’s most senior executives, who together owned 93% of BSMA, made all decisions concerning trader assignments, RMT allocations, and BlueCrest’s related disclosures.
In the Commission’s view, BlueCrest could not have moved as many traders to BSMA as it did, while maintaining BCI’s overall level of allocated capital, without RMT. As designed, RMT sought to mimic the profit and risk profile of certain live traders on a T+1 basis, and though RMT generated positive returns for BCI, it consistently underperformed those traders. At the outset, internal reports estimated that RMT would seek to capture 70-80% of the P&L of the live traders included in RMT; once implemented, RMT experienced slippage, resulting in poorer performance. RMT was also subject to certain modeling errors, as described in the Order, that negatively impacted BCI’s returns.
RMT’s T+1 trading contributed to its underperformance, because it rendered unsuitable to its strategy many profitable trading activities employed by the live traders. Moreover, an internal report on RMT’s first-year performance indicated that RMT’s replication, at times, was the equivalent of a three-day lag in trading, with each day’s lag amounting to an 8% P&L loss, and a two-day lag corresponding to bid/offer slippage. RMT’s next-day trading caused RMT to perform even worse during periods of market volatility. In fact, after RMT incurred significant losses during the June 2013 “Taper Tantrum” (in which U.S. Treasury yields surged in response to the Federal Reserve’s announcement of future tapering of its quantitative easing policy), BlueCrest pulled all remaining BSMA capital from RMT and allocated 100% of new RMT risk to BCI.
BlueCrest’s Disclosure Failures
BlueCrest failed to disclose or actively concealed the above-described events from its investors and BCI’s independent directors. According to the Order, BlueCrest did not disclose or made misstatements concerning BSMA’s existence, the transfer of traders from BCI to BSMA, RMT, and associated conflicts of interest. BSMA was identified in BlueCrest’s 2012 Form ADV filings, but not again, though BlueCrest continued to disclose the existence of other proprietary funds. Thereafter, BlueCrest included general disclosures in offering materials for BCI, indicating that BlueCrest “may” manage proprietary funds and allocate resources to such funds in its “sole discretion.” In the Commission’s view, these broad disclosures were inadequate under the circumstances. Furthermore, members of BlueCrest’s investor relations department understood that they were not allowed to proactively disclose the existence of BSMA and were instructed to rely on the firm’s generalized disclosures instead. And, when due diligence consultants asked for information about BlueCrest’s funds, BlueCrest actively concealed BSMA.
Prior to 2014, there were no disclosures about BSMA, RMT (other than limited references to “quantitative strategies”), or BlueCrest’s related conflicts of interest in any of BlueCrest’s due diligence questionnaires, investor letters, investor presentations, or marketing brochures. Similarly, while touting its successful traders and their active management of BCI “in real time” in such materials, BlueCrest failed to disclose that these traders had been transferred to BSMA, RMT’s existence, or that a sizable amount of BCI’s capital had been allocated to RMT. Additionally, BlueCrest made misrepresentations (or omissions) to BCI’s independent directors concerning RMT’s implementation, performance, allocated capital, and related conflicts.
In 2014, BlueCrest’s conduct came to light after a due diligence consultant saw a reference to BSMA during an on-site examination. When BlueCrest failed to answer the consultant’s follow-up questions, the consultant published a report to its clients downgrading BCI’s rating due to concerns regarding the firm’s failure to disclose BSMA. Thereafter, investors and due diligence consultants began to ask questions, press reports were published, and BlueCrest received numerous redemption requests. BlueCrest assets under management dropped from $13.9 billion in 2013 to $2.2 billion in 2015. BlueCrest decided to stop managing external money and sent all of its client funds, including BCI, to an appointed liquidator.
The Commission charged BlueCrest with violations of §§ 17(a)(2) and (3) of the Securities Act of 1933 and §§ 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rules 206(4)-7 and 206(4)-8 thereunder. Under the terms of the settlement, BlueCrest was censured and required to pay $170 million comprised of $107,560,200 disgorgement, $25,154,306 in prejudgment interest, and a $37,285,494 penalty.
S&K Observations
The Order describes a course of undisclosed, even concealed, conduct designed to benefit BlueCrest’s proprietary fund at the expense of its flagship client fund. This case does not stand for the proposition that an investment manager cannot run strategies concurrently in client and proprietary funds, with appropriate disclosures. The Order makes no mention of the impact that the funds trading in the same strategy had or may have had on BCI, or whether that impact was properly disclosed. Nevertheless, we recommend you take this opportunity to review your fund documents and disclosures to make sure they specifically and adequately disclose potential conflicts of interests in appropriate detail.
Please contact your primary attorney at Seward & Kissel if you have any questions or want any assistance with a review of your firm’s disclosures.
