September 18, 2013 The Securities and Exchange Commission (SEC) charged Shadron Stastney, a partner at a New York based hedge fund, Vicis Capital, LLC with breaching his fiduciary duties by engaging in undisclosed principal transactions in which he had a personal financial interest.
A principal transaction occurs when a registered investment adviser (RIA) acts as a principal for its own account and knowingly and intentionally buys securities from, or sells securities to a client. sells securities to, or buys securities from, a client. A principal transaction may also occur in situations where a controlling owner or an affiliate of the RIA engages in trades with the adviser’s clients. These transactions may lead to abuses, such as price manipulation, and the placement of unwanted securities in clients’ accounts—a practice known as “dumping.”
In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal transactions are potentially very harmful to investors and advisory clients. Principal transactions create the opportunity for RIAs to engage in self-dealing. Principal trading with clients is a clear conflict of interest that must be adequately disclosed to customers.
According to the SEC:
” Shadron L. Stastney, a partner at investment advisory firm Vicis Capital LLC, traded as a principal when he authorized the client hedge fund to pay approximately $7.5 million to purchase a basket of illiquid securities from a friend and outside business partner hired by the firm as a managing director. Stastney required his friend to divest these personal securities holdings as he came on board at the firm because they overlapped with securities in which the hedge fund also was invested. Allegedly, Stastney did not tell the client, hedge fund or any other partners and management at the firm that he had a financial stake in some of the same securities sold into the fund. Stastney personally benefited and received a portion of the proceeds from the sale, and therefore was trading as a principal in the transaction.” The SEC explained that from December 2007 through January 2008, Stastney arranged for his friend and partner to sell the conflicted securities to the client hedge fund – Vicis Capital Master Fund – for $7.475 Million.
As a result of Stastney’s conduct, he agreed to pay more than $2.9 million to settle the SEC’s charges. According to Julie M. Riewe, Co- Cheif of the SEC’s Enforcement Division’s Asset Management Unit, “Fund advisers cannot sit on both sides of a transaction as buyer and seller without the consent of the clients who rely on them for unbiased investment advice. Stastney failed to live up to his fiduciary duty when he unilaterally set the terms of the transaction and authorized it without disclosing that he would personally profit from it.”
The SEC’s order requires Stastney, who lives in Marlboro, N.J., to pay disgorgement of $2,033,710.46, prejudgment interest of $501,385.06, and a penalty of $375,000. Stastney also is barred from association with any investment company, investment adviser, broker, dealer, municipal securities dealer, or transfer agent for at least 18 months. Stastney will be permitted to finish winding down the fund under the oversight of an independent monitor payable at his own expense. Stastney has consented to the issuance of the order without admitting or denying any of the findings and has agreed to cease and desist from committing or causing any violations and any future violations of Sections 206(2) and 206(3) of the Investment Advisers Act of 1940.