According to Bloomberg, US prosecutors are conducting a criminal probe into whether hedge funds inflated the value of bonds to enhance the fees they were paid. Sources told the news media outlet that prosecutors want to know whether hedge funds solicited fake price quotes from brokers, which would have let the funds artificially raise the value of illiquid securities in their portfolios.
Just this week, a witness in the residential mortgage-backed securities fraud criminal trial against three ex-Nomura Holdings Inc. traders—they are accused of lying about RMBS prices to clients—stated under oath that he had given a Premium Point Investments LP trader fake quotes. The witness, ex-broker Frank DiNucci Jr., claims that two of the defendants, Michael Gramins and Ross Shapiro, are among the ones that trained him to lie to customers about bond prices. DiNucci, who pleaded guilty to fraud and conspiracy and making misrepresentations,previously worked at Nomura. He also worked at Auriga USA LLC and AOC Securities LLC.
Because certain securities are hard to price, hedge funds depend on brokers and third parties for estimates and quotes to determine how to value debt. Holding artificially inflated securities in the portfolios can allow a hedge fund to tout a better performance and get paid more for performance and management fees. It also allows them to conceal when some holdings do poorly.