Case N.9 Weavering

Abstract:

Mangus Peterson (Source: Expressen, FT)

A Swedish PM, Mangus Peterson, ran a $639 million Global Macro scheme for almost 5 years, transferring all losses to its related entity. All related parties, including existing investors, directors, auditor and administrator, failed to recognize wrongdoing of Weavering although some hints were given at different stage. This is another interesting case to show that a few extra steps of investigation could have revealed the scheme earlier.

Weavering is the first major fraud in the UK of a management company that was regulated by the FSA.

Case Profile:

Background

Magnus Peterson (the “PM”) started his career in finance at Skandinaviska Enskilda Banken, a major Swedish bank in Gothenburg as an interest rate and foreign exchange trader. In 1989 he moved to the bank’s London office, where he met his future wife, Amanda. In 1995 he became the bank’s Global Head of Proprietary Trading before moving to RJ O’Brien and Associates London, an independent US futures brokerage firm.In 1998, the PM established Weavering Capital (UK) Limited (“WCUK”) and launched Weavering Capital Fund Limited (“WCF”) in the British Virgin Islands where Peterson’s stepfather, Hans Ekstrom (“Ekstrom”), and his younger brother, Stefan Peterson (“Stefan”), served as independent directors. However, WCF suffered heavy losses in the autumn of 1998 and ceased to carry on any significant trading. Then, in March 2000, the PM launched another fund carrying the same name in Bahamas with $50 million. Despite its small size, the fund was an instant success as it returned 140% in the first 10 months of operations. However, in 2001, the things turned upside down: in March the fund lost 15% and in April a further 17%. The PM took more risk to recover losses but this only ended up with a staggering loss of 47% in June.

Shocked by the two consecutive blowups, the PM attempted his third fund with a modified, lower risk strategy, Weavering Macro Fixed Income Fund Limited (the “Macro Fund”) on April 2, 2003. Prior to launching the Macro Fund, the PM confessed to the WCUK board as following:

“The key to the future of the firm lay in a fund of funds vehicle with low volatility,” and that, “… the firm’s old investors were very, very upset and would be unlikely to be the source of future investments.”

His low-risk trading strategy generated stable returns and gradually gained attraction from the hedge fund investor’s community. Between 2004 and 2008, the Macro Fund’s assets under management increased from $27 million to $583 million. The PM’s life style changed as his performance improved. WCUK is said to have its own chalet in the exclusive Alpine ski resort of Verbier. To celebrate another successful year of the Macro Fund, the PM hosted a corporate gathering with his investors over the Italian Garand prix in Monza on September 14, 2008, a day before Lehman Brothers’ bankruptcy. The PM’s success was a mystery to nobody.

Historical Track Record of the Macro Fund

Source: Bloomberg, Hedge Fund Research

Problems

Within the few months after Monza, the Macro Fund’s investors requested redemptions, as they were concerned with everything in the world. As a highly liquid macro strategy hedge fund, investors expected to receive their capital quickly, but redemption proceeds never hit their accounts. Out of $223 million request, the Macro Fund could only meet $90 million. On May 15, 2009, UK’s Serious Fraud Office arrested the PM and announced its investigation on certain trades between the Macro Fund and WCF.

Despite the new “tight risk control” established for the Macro Fund, the PM continued to lose money immediately after the launch of the third fund. The Macro Fund’s first day of trading was August 11, 2003 with $539k and, by August 28, 2003, the portfolio lost 19.3% of the value in exchange trading. For the PM, the Macro Fund was his last chance and he couldn’t lose the battle. Thus, he decided to cause the Macro Fund to enter into swap transactions with WCF, namely two OTC options on FRAs, turning the 19.3% loss into a 3.2% profit. The Macro Fund ended the first month with the profit of 1.34%.

As the Macro Fund continued posting steady monthly performance, the exposure to the transactions with WFC increased. In March 2004, PNC Global Investment Servicing (Europe) Limited, the Macro Fund’s administrator, realized the Macro Fund’s 40% FRA holdings were executed with a related party, WCF, and asked the PM responded the same day, saying that he intended “to dramatically reduce” the Macro Fund’s exposure to WCF so that “the issue will disappear and everything will be expressed as ‘on exchange’ exposure.” On March 3, 2009, the interest rate swaps with WCF represented 94% of the Macro Fund’s net assets.

The transactions with WCF were often backdated in order to generate positive returns at the Macro Fund. WCF is a near-bankrupt entity with no viable assets on its balance sheet and there is no way to honor ballooning liabilities caused by the trades with the Macro Fund. Although the PM claimed that WCF had assets worth about GBP 77 million, PwC, liquidator, determined that its actual value was very much lower. For example, WCF’s stake in a music video company was valued at $37.25 million although the company’s balance sheet for the year showed net liabilities of some GBP 50,000.

On May 30, 2012, the UK’s High Court found the PM guilty of perpetrating a civil fraud against his clients, and Duff & Phelps, the administrators of WCUK, urged the Serious Fraud Office to reopen its probe into the PM’s management of the Macro Fund. The Macro Fund’s investors also sued both E&Y and PNC, accusing their failures to reveal the fraud. In August 2011, the Grand Court of the Cayman Islands ordered both Ekstrom and Stefan to pay $111 million each for neglecting their duties as directors of the Macro Fund.

Recommendations:

Carefully Evaluate Valuation Methodology

• The valuation of the swap transactions with WCF was provided directly by the counterparty and PNC was aware of this fact.
• Prospective investors should review valuation methodology of positions with the administrator, for example, how many 3^rd party broker’s quotes is required to value the portfolio if a quote is not available from regular data vendors (Bloomberg, Reuters, etc.). In order to avoid inappropriate pricing, the administrator should require at least two quotes from independent brokers. In case of Weavering, over 60% of its assets were priced by the counterparty itself and this information should have a very important red flag for prospective investors.

Confirm All ISDA Counterparty

• Any fund which wishes to enter into a swap transaction is required to sign a form called the ISDA (International Swaps and Derivatives Association) Master Agreement.
• An investment manager usually provides a list of all ISDA counterparty and prospective investors should confirm the list with the administrator.
• In Weavering’s case, WCUK entered into the ISDA Master Agreement with WCF, which should alarm prospective investors for potential transactions with related parties.

Avoid Any Fund Conducting Transactions with Related Parties

• It is easy to manipulate transactions with related parties and prospective investors should avoid a fund, which conducts unusual businesses with a related party unless there is a very good reason for the transaction.
• In Weavering’s case, there was no good justification for the PM to cause such transactions with WCF. Several investors had opportunities to learn that the Macro Fund held positions against WCF although they were probably not aware of the size of positions.
• It is a fair question to ask why the PM didn’t attempt to change the name of WCF into something unrelated to the firm or create a completely new entity. But,

Request and Analyze a Transparency Report

• Over the last few years, it is becoming a standard practice for an administrator to provide monthly or quarterly transparency reports, which include all major counterparties. Prospective investors should obtain the reports as far back in time as possible and analyze them. It is important to compare this report against fund’s stated investment strategy and annual financial statements.
• If a manager refuses to provide the report, it is an indication to hide information since it does not cost much for the fund and administrator to generate the report.
• In Weavering’s case, PNC provided the Macro Fund’s directors a quarterly report, which contained critical information including the fund’s counterparty risk against WCF.

Review the Background of Directors

• Until the recent order by the Grand Court of the Cayman Islands, the importance of fund directors was severely underestimated. However, their roles can be very significant if proper corporate governance is established.
• In Weavering’s case, the Macro Fund’s independent directors, the PM’s stepfather and younger brother, were not making decisions independently, allowing the PM to increase exposures to WFC.

Investigate Unrelated Business Activities

• According to ACI Global Corp’s filing on February 10, 2006, Intec Invest Ltd had issued a promissory note of GBP 300,000 to Weavering Capital Fund Limited on November 28, 2002.
• The PM, WCUK and Weavering Capital AB appeared as creditors against 121 Sportsnet, Inc., a Palo Alto, CA-company, which filed Chapter 11 bankruptcy in 2007 with the amount of $1,200,000 plus interests.
• Those unrelated business activities are not fraud by themselves, but indicate the PM used his firm and funds for different purposes from what he might have stated to the investors.

Confirm the PM’s Previous Track Record

• In order to avoid a one-hit singer, prospective investors should carefully assess investment managers’ past track record including funds they previously managed.
• In Weavering’s case, prospective investors could have learned that the PM experienced two fatal blows before launching the Macro Fund, which employed a completely different investment style. The previous two funds were formed in different jurisdictions, but carried an identical name, implying that the PM was trying to hide the failure of the first fund.

Source:

“Fraud probe puts spotlight on Mayfair”, The Telegraph, May 30, 2009, http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5414080/Fraud-probe-puts-spotlight-on-Mayfair.html

“Two arrested in Weavering hedge fund probe”, Financial Times, May 16, 2009, http://www.ft.com/intl/cms/s/0/9802468e-41a6-11de-bdb7-00144feabdc0.html#axzz2D7bGjIpq

Weavering Macro Fixed Income Fund Limited v. Peterson and Ekstrom, Ground Court of The Cayman Islands, Financial Services Division, August 11-26, 2011, http://www.mfsa.com.mt/Files/About%20Us/careers/CPDC/8_9_March_Investment/5.0%20Weavering_Judgement.pdf

Weavering Capital (UK) Limited, et al v. Ulf Magnus Michael Peterson, et al, The High Court of Justice Chancery Division, May 30, 2012, http://www.bedellnews.com/bed128_weavering_capital/Weavering-Engish-decision.pdf