August 20, 2007 / 8:54 PM / 12 years ago

U.S. files fraud charges against Sentinel

CHICAGO (Reuters) - The U.S. Securities and Exchange Commission filed civil fraud charges on Monday against Sentinel Management Group Inc, the cash management firm serving the U.S. futures industry that filed for Chapter 11 bankruptcy protection late on Friday.

In a complaint filed in U.S. District Court in Chicago, the SEC accused Sentinel of defrauding clients by improperly commingling, misappropriating and leveraging their securities without their knowledge in violation of the Investment Advisers Act.

According to the complaint, the SEC alleged that Sentinel transferred at least $460 million in securities from client investment accounts to Sentinel’s proprietary “house” account.

Sentinel also used securities from client accounts as collateral to obtain a $321 million line of credit as well as additional leveraged financing, the SEC alleged.

The SEC also accused Sentinel of not disclosing to its clients it practices of “commingling,” which involved transferring and misappropriating their assets. Sentinel failed to inform them that their investment portfolios were highly leveraged as a result of the financing activities, the SEC said.

“To the contrary, Sentinel provided its clients with daily account statements that did not reflect the improper activities,” the SEC said in the complaint.

Sentinel did not return a call seeking comment, nor did its attorney Ronald Barliant respond to an e-mail.

The SEC is also seeking an emergency temporary restraining order telling Sentinel to immediately cease in engaging in illegal conduct.

The SEC actions came as John H. Squires, the judge hearing the company’s case in the United States Bankruptcy Court for the Northern District of Illinois, heard first-day motions in a courtroom packed with attorneys representing Sentinel and many of its more than 200 creditors.

Looking out over the crowded room, Squires predicted the case would be “a mega Chapter 11.”

During the hearing, Christian Kemnitz, an attorney representing Discus Master Limited, an investment partnership based in the British Virgin Islands and one of Sentinel’s biggest clients, accused the company of “disturbing” and “illegal” behavior.

“There’s more going on here than simple mismanagement,” Kemnitz said.

Earlier on Monday, a document filed with the bankruptcy court revealed that the National Futures Association, the self-regulator for the futures industry, had faulted Sentinel’s record-keeping just days before the company sought court protection.

The NFA went to Sentinel’s offices on August 14, its filing to the court shows, and reviewed the firm’s books and records. That review found “that Sentinel failed to maintain adequate books and records, including records to demonstrate the location” of some accounts and whether or not the accounts’ assets were in any way encumbered, the NFA document said.

As a result, the NFA issued an order prohibiting Sentinel from “liquidating, selling, transferring, encumbering or otherwise disposing of any securities.” That order came one day after the company, which managed about $1.6 billion of assets, had already frozen client accounts — a move that helped roil global financial markets last week.

In the letter it sent to clients informing them of the freeze, Sentinel blamed the redemption suspension on the “liquidity crisis” in the market. “Investor fear has overtaken reason and has induced a period in which most securities have simply ceased to trade,” it said.

But in the complaint filed on Monday, the SEC said Sentinel’s explanation was “false and misleading.”

For months, it said, clients had suffered “undisclosed losses and risks of losses due to Sentinel’s undisclosed use of leverage and commingling and misappropriation of clients’ securities.”

The SEC said that on the day Sentinel froze accounts, the statements it was providing clients listed “hundreds of millions of dollars in securities that were not held by Sentinel at all, were held by Sentinel and treated as its own assets, or were pledged as collateral for loans extended to Sentinel.”

News about Sentinel came on the heels of problems at funds managed by Bear Stearns Cos, Goldman Sachs Group Inc and other companies in the United States and abroad.

The bankruptcy filing said Sentinel estimated assets and liabilities both exceeded $100 million, but it wasn’t more specific. It said it estimated it had at least 200 creditors.

Additional reporting by Rachelle Younglai in Washington

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