Yesterday, the SEC announced that it had brought enforcement actions against three advisory firms and six individuals for misconduct including improper use of fund assets, fraudulent valuations, and misrepresenting fund returns. Notably, the SEC stated that the cases were "part of an initiative to combat hedge fund fraud by identifying abnormal investment performance."

Earlier this year in congressional testimony, SEC Enforcement Director Robert Khuzami mentioned an eye-opening agency initiative concerning hedge funds.  He said his division was taking a look at at hedge funds that outperform market indexes by 3% on a steady basis, calling such performance “aberrational.” The idea generated some buzz among enforcement defense lawyers at the time, but nothing much really seemed to come of it until yesterday's announcement.

The SEC stated yesterday that the new cases were part of the "Aberrational Performance Inquiry" initiative, under which the Enforcement Division's Asset Management Unit uses "proprietary risk analytics to evaluate hedge fund returns. Performance that appears inconsistent with a fund's investment strategy or other benchmarks forms a basis for further scrutiny." Khuzani added that the agency was 

using risk analytics and unconventional methods to help achieve the holy grail of securities law enforcement — earlier detection and prevention.” This approach, especially in the absence of a tip or complaint, minimizes both the number of victims and the amount of loss while increasing the chance of recovering funds and charging the perpetrators.

Robert Kaplan and Bruce Karpati, Co-Chiefs of the Asset Management Unit, stated that the unit was applying analytics across the investment adviser space — "beyond performance and beyond hedge funds.” They said that the advisers and portfolio managers involved in these cases were reporting extraordinary, "outlier" returns that were "in most cases, too good to be true" or a sign that "something else was amiss."

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