Regulator On Board of Embattled Hedge Fund

Richard Y. Roberts served as a commissioner for the U.S. Securities and Exchange Commission from 1990 to 1995. Today, he sits on the board of a hedge-fund advisor that the SEC accuses of fraud.

The SEC filed a lawsuit Wednesday in Manhattan federal court against Jersey City, N.J.,-based Yorkville Advisors LLC. The lawsuit also named founder Mark Angelo, age 40, and chief financial officer Edward Schinik, age 47.

The regulator accuses the firm of lying about the values of its investments to attract more money from investors and bag ever-higher management fees.

Mr. Roberts isn't named in the action or accused of any wrongdoing.

I just found it interesting when I tripped across his name in a press release the company put out in 2007. "Rick's extensive regulatory and legislative experience is a significant asset," Mr. Angelo said in the release, "and his presence on the board will be extremely valuable to our firm."

I thought maybe his value had run its course, given the fraud allegations, but apparently not.

"I do still serve on the board," Mr. Roberts confirmed to me in an email on Wednesday, "but I do not have any comment on the SEC enforcement case."

His embattled colleagues, meanwhile, deny all the allegations and have offered up some brazen words for the regulator Mr. Roberts once served.

"We will not be victims of this free-money shakedown," Mr. Angelo said in a statement released to media, "and will vigorously defend against the SEC's baseless allegations."

Mr. Angelo went on to allege the SEC simply doesn't want to admit its costly investigation of Yorkville came up with zilch. "In many cases the SEC .. files lawsuits after fruitless investigations to justify the time and taxpayer money that it has wasted," he said.

As for the SEC, it counts Mr. Angelo as the seventh case to come from its "aberrational performance inquiry." If a hedge fund reports suspicious returns, the SEC runs the numbers and finds the fraud.

"The analytics put Yorkville front and center on our radar screen," said Bruce Karpati, chief of the SEC enforcement division's asset management unit, in a press release. "When we looked further we found lies to investors and the firm's auditors as well as a scheme to inflate fees by grossly overvaluing fund assets."

This is a complicated case for the lawyers to hash out. But generally, I find it difficult to identify an industry with a greater economic incentive to fudge the numbers than the hedge-fund industry.

Hedge-fund managers ask for fees as large as 2% of the value of the assets under their management. Then they want as much as 20% of any profits they make. Then they swear they'll outperform the investing world after taking all this loot off the top. It's a dubious claim on its face, and yet it's made industrywide.

For any hedge fund advisor, the pressure is simply enormous to keep the assets from declining and the performance from slipping. And we all know that human nature is what it is, even if you are Lance Armstrong.

Yorkville's stated focus is "on providing alternative funding options for microcap and small-cap publicly traded companies." It purportedly managed about $1 billion at its peak.

The SEC alleges that by fraudulently inflating values, the firm lured more than $280 million from pension funds and other investment pools, resulting in at least $10 million in excess fees.

The lawsuit lists some interesting ways Yorkville allegedly did this.

Remember Levitz Furniture Inc.? "You'll love it at Levitz."

Even after Levitz liquidated in a 2007 bankruptcy, Yorkville continued to value the convertible securities it issued to the disappearing furniture store at more than $17 million, the SEC said in its complaint. In March 2008, Yorkville received a bankruptcy settlement of less than $1.3 million--or as they say in the bankruptcy business, pennies on the dollar. But Yorkville did not take this significant writedown on its books, the SEC said.

So how does anyone trust that the numbers a hedge fund advisor is reporting are true? Some investors may feel more at ease if there's a former SEC commissioner on board.

Mr. Roberts is a partner in a Washington-based lobbying and consulting firm, Roberts Raheb & Gradler LLC. He's achieved the Washington dream of passing through the proverbial revolving door and evolving from regulator to the regulated.

Lynn Turner, a former chief accountant for the SEC, described Mr. Roberts as "as straight shooter."

The unfortunate truth is that companies like to stack their boards with former regulators to bolster their credibility.

I've written about this before -- usually in more extreme cases. Take for example the tale of Bernerd Young, a former top executive at the Financial Industry Regulatory Authority. He became chief compliance officer for R. Allen Stanford, who was convicted in the second-largest Ponzi scheme in history. Mr. Stanford also managed to hire the legal services of Spencer Barasch, head of the SEC's Fort Worth regional office from 1998 to 2005.

"You still have to step back and remember that these people are human," Mr. Turner said. "Just because you have a former government regulator on board doesn't mean they are getting the job done."

My favorite revolving-door story is about a former SEC attorney named Eric Swanson marrying a woman named Shana Madoff, the niece and chief compliance officer of another famous Ponzi-schemer.

They say love is blind. Money is, too.

(Al's Emporium, written by Dow Jones Newswires columnist Al Lewis, offers commentary and analysis on a wide range of business subjects through an unconventional perspective. Contact Al at al.lewis@dowjones.com or tellittoal.com)