Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Thursday, October 16, 2008

SEC Settles "Portfolio Pumping" Charges Against Medcap Management

The SEC settled charges that San Francisco investment adviser MedCap Management & Research LLC (MMR) and its principal Charles Frederick Toney, Jr. reported misleading results to hedge fund investors by engaging in a practice known as "portfolio pumping."  The SEC alleged that Toney made extensive quarter-end purchases of a thinly-traded penny stock in which his fund was heavily invested, more than quadrupling the stock price and allowing him to report artificially inflated quarterly results to fund investors. Without admitting or denying the SEC's allegations, MMR and Toney have agreed to settle the charges by paying financial penalties and agreeing to an order barring Toney from acting as an investment adviser for at least one year.

According to the SEC's order, MedCap Partners L.P. (MedCap), a hedge fund run by MMR and Toney, was suffering from dramatic losses and facing increasing redemptions from fund investors by September 2006. Over the last four days of the month, Toney — through a separate fund that MMR managed — placed numerous buy orders for a thinly-traded over-the-counter stock in which MedCap already was heavily invested. Toney's buying pressure caused the stock price to more than quadruple, from $0.85 to $3.72.

The SEC alleges that because the stock represented over one-third of MedCap's holdings, the brief boost in its price inflated MedCap's reported value by $29 million, masking what would otherwise have been a 40 percent quarterly loss for MedCap. Immediately after the quarter ended, Toney reported to MedCap's investors that the fund's investments had begun to "bounce" and that the fund's performance was improving. Toney failed to disclose that this "bounce" was almost entirely the result of his four-day purchasing spree. Following MMR's brief buying activity, both the stock price and MedCap's asset value declined to their previous levels.

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