Print Version: 2012-01-31 Case Study – Millennium
Michael Balboa, portfolio manager of Millennium Global Emerging Credit Master Fund, Ltd., not only hid losses, but also inflated the net asset value of the Fund by $163 million through manipulating pricings of two obscure warrants. GlobeOp was a valuation agent and independently priced the fund’s NAV and Deloitte conducted its annual audit and issued an unqualified opinion when the misconduct was underway. How could Balboa successfully deceived the reputable service providers and avoided immediate collapse of the Fund?
In 2006, Michael Balboa (“Balboa”), an experienced credit trader, joined Millennium Global Investments, Ltd., a reputable hedge fund management firm with over $15 billion assets, after his 3-year stint at Rainbow Advisory Services, Ltd., another London-based hedge fund manager. He became a portfolio manager of newly launched Millennium Global Emerging Credit Master Fund, Ltd. (the “Fund”). Balboa attracted many investors with his impressive over-25% annualized returns and managed $844 million. The Fund’s primary investments are emerging market credit instruments.
GlobeOp Financial Services, Ltd. (“GlobeOp”) was the Fund’s independent administrator and Deloitte & Touche (Bermuda), Ltd. was the Fund’s independent auditor. Both are top-tier service providers in the hedge fund industry. Balboa arranged for GlobeOp to serve as the Fund’s independent “valuation agent.” In this capacity, GlobeOp was described in the Fund’s offering memoranda as being “responsible for the calculation of the [Fund’s] New Asset Value” and that, “[w]herever practicable, [would] use independent sources” for this purpose. The Fund’s DDQ described that “[t]here are no assets valued in house,” that “[m]anager marks are not used to price the portfolio” and that “GlobeOp values 100% of the [Fund’s] portfolio.”
As the financial crisis intensified in the summer of 2008, emerging markets were hit particularly hard. However, the Fund’s 180 investors were relieved as they received monthly statements indicating Balboa’s Fund was successfully weathering the turbulence although the returns were not as robust as before.
Unfortunately, it was far from reality. Balboa had two large investments, representing roughly 20% of NAV, in the Nigerian payment adjustment warrants and Uruguayan value recovery rights (together, the “Warrants”), whose real value fell capriciously during the summer. In order to save the Fund from a catastrophe, Balboa inflated the values of both securities, so that investors will not notice what was really happening inside the portfolio. According to the court documents, the valuations for the Warrants collectively increased thirteen-fold by $157 million while the rest of the Fund’s portfolio experienced close to $200 million in losses.
On October 16, 2008, the Fund petitioned the Supreme Court of Bermuda for voluntary liquidation and was placed under the control of three court-appointed joint provisional liquidators after the Fund’s portfolio suffered nearly $1 billion in losses.
In order to hide massive losses on his two largest positions, Balboa asked independent broker, Gilles De Charsonville (“Charsonville”), and another broker (the “Broker A”) for help. Although GlobeOp conducted a full valuation of the Fund’s portfolio on a monthly basis, Balboa knew that GlobeOp still relied on quotes from brokers to value securities, which were traded over-the-counter, including the Warrants. Balboa instructed GlobeOp to obtain independent quotes from various sources, including Charsonville and the Broker A, who in fact received kickbacks from Balboa. An independent fund administrator collects directly from each broker an electronic file which contains quotes of securities the broker is dealing with. As a best practice, an administrator usually collects more than one quote per security, so that they can use average price to avoid irregular pricing activity.
Balboa’s scheme was successful because these securities were so thinly traded and Charsonville and the Broker A were eventually the only brokers who provided the quotes to GlobeOp and GlobeOp’s operating policy allowed itself to evaluate the Fund’s NAV with only a single broker quote, no matter how reliable the pricing was. Deloitte also believed the valuation of these securities at the annual audit for 2007, which was conducted early 2008. Neither GlobeOp nor Deloitte reported any wrong doing until the collapse of the Fund in Oct 2008.
Ask a fund administrator to explain details of valuation policy and monthly valuation process, especially for those illiquid positions, and confirm there is adequate check-and-balance system in place
- Request a list of brokers which provide month-end quotes from both a fund administrator and an investment manager; make sure the listed names match
- Contact brokers and review their background information if the company names are unfamiliar
- Confirm with the listed brokers if they actually provide quotes to the administrator
- Confirm that the administrator is legally responsible for the monthly valuation
- Request a copy of duly executed administration agreement
- Check if the administrator receives the quotes directly from brokers
- Ask the administrator to provide the number of quotes used for valuation for top 5 positions
- Ask the administrator to provide breakdown of portfolio by the number of quotes (no quote/1 quote/2 quotes…)
- Ask whether the administrator cross-check valuation of a security with the same or similar security owned by other clients; if the answer is no, ask why it does not cross-check
U.S. Securities and Exchange Commission v. Michael R. Balboa and Gilles T. De Charsonville (2011). U.S. District Court for the Southern District of New York