North Hills: The Diversified Fund That Hid Its Biggest Investment

In the North Hills CFTC fraud case, a federal court ordered North Hills Management and its sole owner to pay a $26 million joint civil penalty over diverted commodity pool money and false performance reports. The court’s findings describe at least $13 million taken for the owner and his wife’s personal use while investor statements showed gains. For someone preparing those reports or handling the transfers, the gap between the statement and the assets is the story.

The court’s June 2010 consent order sets out the findings in the Commodity Futures Trading Commission’s action. North Hills sold diversification, put more than half its assets into another commodity fund, and left that investment off a report purporting to identify its holdings. When the other fund failed, the findings describe another layer of concealment around money recovered from it.

What North Hills Promised Investors

North Hills promised a diversified fund of funds with moderate risk. The court’s findings describe an investment that began as an enhanced stock-index fund and changed in 2001 to a fund investing in other funds. Investors were told that multiple managers and strategies would produce a market-neutral return of approximately 12%.

That pitch came with a reporting promise. The offering documents said investors would receive monthly reports and annual financial statements audited by an independent certified public accountant. The order found that investors received monthly statements consistently showing positive returns and made additional investments in reliance on them. The promised annual statements were not provided as required.

North Hills Management operated the fund and served as its general partner. In the commodity-pool business, the operator runs the investment vehicle and solicits or receives participants’ money for commodity-interest trading. Here, that role put the same business in charge of the money, the investment choices and the account of those choices delivered to investors.

How North Hills Diverted Commodity Pool Money

North Hills diverted commodity pool money through purported loans to its own manager, according to the consent findings. Promissory notes stood in place of the assets taken from the fund.

The accounting matters. A financial statement for the year ending in 2002 listed notes receivable from North Hills Management as fund assets. Some participants did not receive that statement until around or after November 2008. The money had left for personal use, but a debt owed by the manager appeared among the fund’s assets.

A consolidated demand note dated December 31, 2004 carried the manager’s promise to repay. North Hills Management signed for itself and for the fund. According to the order, the manager apparently never demanded payment from itself or its owner.

Payable on demand. With the borrower controlling the demand.

By November 2008, a letter to certain investors disclosed that, apart from the outside-fund investment, the remaining assets consisted of notes payable by North Hills Management, which could not repay them. That disclosure explains why a reported asset balance and money available to an investor could be so far apart.

The Portfolio Did Not Match the Pitch

North Hills concentrated approximately $18 million, more than half the fund’s assets, in the Philadelphia Alternative Asset Fund. The consent order found that this contradicted the diversified strategy investors had been sold. The outside fund traded exclusively in commodity futures and options.

The allocation also paid the manager personally. Under a referral agreement with Philadelphia Alternative Asset Management, the business running that outside fund, he received approximately $356,000 in fees tied to the North Hills investment. The court found that investors were not told about that compensation.

The concentration became known to North Hills participants in July 2005, after the Commodity Futures Trading Commission brought a fraud action against the outside fund’s operator and its principal and the assets were seized. Even then, the North Hills manager did not disclose his referral-fee arrangement.

The same decision thus had different consequences for the investors and the manager. Investors carried the concentrated exposure. The manager collected compensation for directing their money there. The offering’s diversification language told investors neither part of that story.

Performance Reports Hid the Difference

North Hills performance reports concealed both the personal diversion and the concentrated investment, the court found. The defendants retained a purported third-party sub-advisor to reassure certain investors about compliance and diligence. Reports issued through that sub-advisor in June 2004, June 2005 and June 2006 omitted the assets taken for personal use.

The June 2005 report purported to list the hedge funds holding North Hills money. It named other allocations and omitted the Philadelphia Alternative Asset Fund altogether. The fund’s largest investment was missing from the document meant to explain its investments.

A positive return encouraged investors to stay or add money. A list of other funds sustained the diversification pitch. The reports concealed both what the manager owed the pool and where the pool had concentrated its money.

The manager’s own standard makes the contrast sharper. The North Hills order recounts his sworn testimony in the other fund’s case in 2006: he said that its manager should have disclosed personal borrowing and that he would not have invested had he known about it. We call that a double standard. Personal borrowing was disqualifying when someone else did it, yet North Hills investors were kept in the dark about his own.

The Other Fund’s Recovery Became Another Money Trail

The court found that North Hills concealed payments from the failed outside fund. A receiver appointed in the separate action gathered and distributed assets. North Hills participants expected their share of those recoveries.

In September 2006, the manager signed an undisclosed participation agreement with Stonehill Institutional Partners. It gave Stonehill an interest in North Hills’s outside-fund position and the money payable from it. Instructions to the receiver directed distributions to Stonehill while correspondence and other information continued to go to the North Hills defendants.

Stonehill made upfront payments, then kept 20% of subsequent distributions and forwarded the remaining 80% to the manager in the fund’s name. The order says he received approximately $8 million from Stonehill in North Hills’s name.

Investors received a different account. The manager sent written updates about the receivership and prospects for recovery without mentioning the agreement or the payments already received. Monthly statements did not credit or otherwise account for those distributions. Money moved in the fund’s name while its investors continued to hear about the prospect of recovering it.

Redemption Requests Put the Statements to the Test

The consent order describes investors seeking redemptions that arrived only partly or not at all. One example puts the figures against each other: in January 2008, two participants requested full redemption of their $13.8 million balance, or at least the portion said to be outside the failed investment. In March, the defendants paid them only $1 million.

Monthly statements continued to show positive balances. The same participants demanded documentation and an accounting in October 2008 and eventually learned that the manager had taken fund assets as personal loans.

What the North Hills CFTC Case Decided

The Commodity Futures Trading Commission brought its civil action against North Hills Management and its owner in February 2009. The June 11, 2010 consent order imposed permanent restrictions on trading, soliciting trading funds and registration. The March 2, 2015 supplemental consent order made the company and owner jointly responsible for the civil penalty.

When the Report Becomes Part of the Scheme

Other commodity cases show how reports conceal missing assets. In their complaint against Rust Rare Coin, the Commodity Futures Trading Commission and Utah’s securities regulator alleged that pooled-silver statements described trades that had never occurred:

The agencies also alleged that statements given to different investors sometimes carried inconsistent prices and quantities for the same trading dates, even though investors had been told they shared a single trading account. North Hills’s omitted investment and Rust Rare Coin’s alleged invented trades show different ways a statement can conceal what the pool actually holds.

Peregrine Financial Group shows how customer-fund verification itself was compromised. The FBI’s account of the criminal case describes forged bank statements and a post-office box controlled by the chief executive to intercept confirmations. For North Hills, the relevant comparison is between the reported portfolio, the manager’s notes and the actual investment and distribution records.

What Evidence Is Required to Prove Fraud?

For a pool case like North Hills, useful evidence connects what investors were promised, where their money went, and what the manager reported afterward. We work through those connections with you.

If you know who supplied the performance figures or how a payment in the fund’s name reached the manager, we can connect that knowledge to the reports and transfers. Those details help CFTC whistleblower lawyers who understand commodity pools connect documents that tell only part of the story on their own.

For qualifying CFTC whistleblowers, the program provides an aggregate award of 10% to 30% of monetary sanctions collected. The False Claims Act is a separate program. A whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers. We assess your information and the program that fits it with you.

You Know What the Pool Reports Left Out

If you can explain the missing investment, the manager’s loan or the payment investors never saw, talk with our whistleblower experts about what happened inside the pool. We build the case around your knowledge, bring in CFTC whistleblower lawyers who understand fund accounting and concealed conflicts, and remain your partners through the enforcement and award process.