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Due Diligence

The Weavering Case: A Fine Line between Negligence and Fraud

Posted on 13 Jul 2012

Mrs. Justice Proudman stresses the need for more investor-led due diligence

On 30 May 2012, Mrs. Justice Proudman issued her judgment on the Weavering case, UK’s largest hedge fund fraud to date. In March 2009, the collapse of the Cayman Islands-based Weavering Macro Fixed Income Fund led to financial losses amounting to more than USD 600 million and made headlines across the world. The judgment was the outcome of a civil proceeding which started just a month after the Serious Fraud Office (“SFO”) had controversially abandoned its criminal investigation into the case, even after a Cayman Island court had awarded damages of USD 111 million against two of the fund’s directors.

In a recent turn of events however, and following a review of the High Court civil judgement undertaken by the SFO, director David Green decided that the case be reopened, effective 6 July 2012.

Three of the four main defendants, Mr. and Mrs. Peterson and Mr. Dahbia, were directors at Weavering Capital (UK) Ltd (an FSA regulated manager), and Mr. Platt was a senior and highly paid employee at the company. Claims of fraud were made against Mr. Peterson and Mr. Platt, the latter being acquitted for fraud but liable in the tort of negligence. Mrs. Peterson and Mr. Dahbia were charged with negligence which allowed the fraud to happen. All were ordered to pay a total of USD 450 million in damages.

Mrs. Justice Proudman highlights many red flags in the way Weavering Capital was being managed:

1. Weak Corporate Governance – Weavering Capital was a clear case of bad corporate governance. Through its brief existence, most directors and other senior employees were not independent and/or fit for their role. This allowed Mr. Peterson to manage the fund however he saw fit without ever being challenged, hence establishing his bad habits as common practice (e.g. including signing important documents in the name of others).

2. Deceptive Marketing and Offering Documents – For the most part, the information disclosed to investors was misleading. The documents given to investors about the fund, mainly the Due Diligence Questionnaire (“DDQ”) and the Offering Memorandum (“OM”), contained erroneous information about risk management, swaps, pricing, investments and OTC transactions. Investors should have been able to spot these weaknesses by verifying the information.

3. Inconsistent Track Records – Investors could also have noticed inconsistencies between daily and final NAVs. Daily values were indeed manipulated by Mr. Peterson to show low volatility. In fact, concerns about these discrepancies had been raised in 2008 by Mr. Patrice Neyret, an asset management investor at GT Finance, but those were quickly eradicated by Mr. Peterson and Mr. Platt without attracting much attention.

4. Weak Middle & Back Office Procedures – Irregularities also manifested themselves in trade processes and book keeping, which was described by the judge as “amateurish and irregular”. As with many other compliance matters, both Mr. Peterson and Mr. Platt had the tendency to dismiss those processes as unimportant. This culture of not respecting standard compliance is widespread in the industry but again, it is easy to check the attitude of a company towards compliance.

5. Breach of Investment Guidelines – Mr. Peterson also failed to comply with investment concentration restrictions while investing in swaps, which in terms of risk management, strongly differs from the diversification principle that was advertised by the fund through the OM, the DDQ, and other marketing tools.

The Weavering case is a clear example of how paying attention to simple processes such as due diligence and corporate governance would have raised many red flags that could have prevented investors and stakeholders from getting involved in this offering. Interestingly, Mrs. Justice Proudman noted that “each investor ought to have done more, by due diligence, to detect what was really happening”.

The issuance of this judgement coincides with the publishing of the Financial Times Guide to Investing in Funds, a new book written by Laven Partners’ CEO Jerome Lussan. In this publication, Mr. Lussan encourages investors to carry out operational due diligence and pay particular attention to corporate governance, compliance, and investment processes. On one hand greater awareness would help investors avoid fraud and major financial losses, while on the other hand this would compel businesses to be more responsible and to better measure risks. Mr. Lussan argues that you can also delegate due diligence but that the book is aimed at teaching investors how to perform it alone and therefore at no cost.