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May 16, 2018  

Premium Point Debacle Detected Early On

A large fund-of-funds manager raised a red flag about Premium Point Investments’ asset-valuation policy seven years before a federal grand jury indicted the firm’s founder and two other executives on fraud and conspiracy charges.

In 2011, while conducting a due-diligence review of Premium Point, the unidentified fund of funds challenged a proposal by the fund manager to use “imputed” broker quotes to mark portfolios of mortgage-backed securities — rather than the actual bids quoted by brokers. That was among the fraudulent practices federal prosecutors cited in their May 9 indictments of Premium Point founder Anilesh “Neil” Ahuja, former partner Amin Majidi and former trader Jeremy Shor. All three pleaded not guilty in U.S. District Court in Manhattan.

“This is very unusual and we have never seen it in a valuation policy before,” a fund-of-funds executive wrote to Premium Point, according to previously unreported sections of the indictment. “Our initial comments were to ask for less manager involvement in valuation process, not more . . . Has this alteration of broker quotes been occurring all along?”

In response to the email, Premium Point immediately amended its proposal to exclude the use of imputed broker quotes. That was enough to satisfy the fund-of-funds manager, which soon invested more than $100 million with the firm. But according to the indictment, Premium Point used imputed broker quotes anyway — despite follow-up inquires from the fund-of-funds manager seeking assurances that the alleged fund wasn’t deviating from its policy.

The Premium Point executives also were accused of inducing brokers to furnish inflated mortgage-bond prices so that Premium Point could pump up its net asset values and artificially boost returns. That element of the alleged fraud apparently went undetected by the fund of funds.

After the indictments were unsealed on May 9, consultant Aksia began reviewing the allegations to determine if its own due-diligence procedures would have picked up on the scheme — something Aksia routinely does when fraud cases come to light. Simon Fludgate, who oversees operational due diligence for Aksia, said analyzing a fraud after the fact is easy in hindsight, but developing procedures to uncover possible malfeasance in the first place is challenging. In reviewing the Premium Point complaint, Fludgate noted that while the “imputed-pricing” methodology is something Aksia does look for, collusion by brokers is difficult to detect.

According to the indictment, Ahuja and his cohorts overstated the net asset value of the Premium Point Mortgage Credit Fund by some $200 million. The scheme was aimed at boosting the fund’s returns to bring them in line with other mortgage-bond hedge funds.

But as market conditions weakened in 2015, investor withdrawals mounted, whittling the fund’s reported assets to $710 million as of Feb. 29, 2016, from more than $1 billion two years earlier. To avoid booking even steeper losses by selling overvalued bonds in a down market, the firm liquidated other positions while continuing to inflate the values of the mismarked securities, prosecutors allege.

The discrepancies came to light in 2016 when Premium Point’s auditor, Ernst & Young, declined to approve the fund’s financial statements for 2015 and told the manager it likely would have to restate the results. Weeks later, Ahuja notified limited partners that he was liquidating the fund and shutting down the firm.

Ahuja, who launched Premium Point in 2009, previously headed mortgage-bond trading at Deutsche Bank.