Hedge Fund Demands $100 Million From Its Compliance Team After SEC Probe (2024)

(Bloomberg) -- Wall Street firms usually grumble in private after getting punished by regulators. Anthony Melchiorre’s Chatham Asset Management is dragging its advisers into a public legal battle for $100 million.

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The $6 billion hedge fund is demanding that Adviser Compliance Associates not only cover Chatham’s costs for settling a US probe last year, but also damage to its business. In an unusual lawsuit, Chatham claims the outside consultant, founded by former regulators, failed to prevent trading practices that ran afoul of authorities.

Melchiorre and Chatham agreed to pay more than $19 million in April to settle Securities and Exchange Commission accusations that the firm improperly traded bonds of American Media, the longtime owner of the National Enquirer tabloid. Wall Street’s top regulator said Chatham used outside brokerages to move the investments at elevated prices among funds it managed.

“Chatham sought, received and followed advice from ACA that certain trading practices did not run afoul of the SEC’s cross-trading rules,” Melchiorre, 56, said in a statement through a spokesman. “ACA gave it improper advice and failed to flag these trades as problematic.” The hedge fund intends to vigorously pursue the matter, holding ACA accountable, he said.

The firm filed the lawsuit days after resolving the SEC’s probe without admitting or denying wrongdoing. ACA and Chatham are set to appear in federal court in New Jersey next week to take the case forward, after a judge ruled in December that accusations of gross negligence, negligent misrepresentation and breach of fiduciary duty can proceed.

“This is certainly an unusual case,” said Sarah Krissoff, a former federal prosecutor now at law firm Cozen O’Connor. “This might not be the path many firms might choose, but they have decided to take an aggressive path.”

ACA had tried to get the case thrown out. The investment firm is seeking “to foist blame on Adviser Compliance Associates for Chatham’s own violations” of federal securities laws and SEC rules, the consultant’s attorneys wrote last year in their motion to dismiss the lawsuit.

The SEC found the hedge fund and Melchiorre set the prices for the trades in question, the lawyers noted. And nothing in the complaint “alleges that Chatham ever informed ACA that it was pre-arranging the sales prices of the bonds, or that ACA knew of the practice, much less that ACA advised Chatham to engage in it.”

‘Street Fighter’

A Chicago native and a cornerback on his high school football team, Melchiorre has built a reputation on Wall Street as a hard-charging investor unafraid of confrontation. He parlayed stints at Donaldson, Lufkin & Jenrette, Goldman Sachs Group Inc. and Morgan Stanley into joining the “Jersey Boys,” the clique of hedge fund managers setting up firms across the Hudson River. In his case, it was in the leafy New Jersey suburb of Chatham.

Billionaire Leon Cooperman, who invested with Chatham, has called the firm “scrappy” and unafraid of litigation. Melchiorre’s former boss at Morgan Stanley once called him a “street fighter,” noting that there are people who don’t like him because they are losing to him.

The trades at issue began more than a half-decade ago. After building up a concentrated investment in American Media — now known as a360 Media — Chatham decided to spread the bet among its various funds. According to the SEC, the firm carried out more than 100 of the so-called rebalancing trades.

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Chatham sought advice from the compliance consultant, which according to the hedge fund said the firm could sell the bonds and repurchase them.

“The foundational principle underlying the advice was to ensure that the transactions occurred at independently derived market prices,” the SEC wrote in a settlement document.

Chatham’s regulatory troubles began when the SEC conducted an on-site examination in 2018 and sought details about whether the firm had conducted cross trades among funds it managed, an industry practice that had piqued the agency’s interest.

In early 2019, Bloomberg published a report on Chatham’s bond trading, mentioning that the firm had faced questions during an SEC exam. In its lawsuit against ACA, the hedge fund said that some investors redeemed existing investments or refrained from making new ones after the SEC’s scrutiny was “leaked to the public.”

A key problem, according to the SEC, was that the American Media trades were executed at prices proposed by Melchiorre and not at levels independently derived from the broader market. Some transactions ended up raising prices on the bonds, the regulator said, estimating that Chatham’s clients ended up paying $11 million in additional fees to the firm because of the rebalancing trades.

As part of their settlement with the agency, Chatham and Melchiorre forfeited those payments, plus interest. The regulator didn’t name or fault ACA in the case.

“Chatham fails to make clear that the SEC suggested no wrongdoing by ACA or that ACA knew and advised Chatham of the pre-arranged trading pattern,” the consultant told the court in its bid to have the case tossed out. “Chatham has not and cannot plead that ACA ever knew specific facts found by the SEC.”

--With assistance from Ava Benny-Morrison.

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