Regulatory agency asking about hedge fund’s risk controls, disclosures following meme-stock losses
According to persons familiar with the situation, the Securities and Exchange Commission is investigating Melvin Capital Management‘s risk management and investor disclosure after the hedge fund was crushed by the meme-stock rally last year.
The regulator has contacted hedge fund investors in recent months to investigate what Melvin founder Gabriel Plotkin and other senior executives told them following the meme-stock rally in January 2021, as well as whether the hedge fund misled investors when it raised money last year.
According to the persons, the SEC requested Melvin’s general interactions with investors and sought information regarding what the firm provided to clients about the risks of its investment plan. Melvin is winding down after Mr. Plotkin’s death.
The probe is still in its early stages, and no formal allegations of wrongdoing have been made. According to the sources, it is being handled by the enforcement division’s asset-management team in Washington, D.C. The SEC and other law-enforcement agencies are looking into the frantic trading in early 2021 that pushed shares of GameStop Corp. and others skyrocketing. It was unclear whether the broader inquiries are tied to the SEC’s investigation into Melvin.
Melvin lost $6.8 billion, or more than half of its assets under management, in January 2021, after retail and other investors teamed together to target the fund’s short bets. The loss was one of the fastest and steepest for a hedge fund since the 2008 financial crisis, with Melvin losing more than $1 billion per day at its worst. Melvin received $2.75 billion from Ken Griffin’s Citadel and Steven A. Cohen’s Point72 Asset Management in late January in exchange for a percentage of its income, in a transaction that allowed the business to reduce its debt rather than sell out of its positions.
By the end of January, the meme-stock frenzy had subsided, and Melvin had obtained new funds from other investors. After weathering an unanticipated market event, Mr. Plotkin and other executives told customers in virtual meetings that he wanted to soldier on and that the firm had enhanced its risk-management methods, particularly in relation to the fund’s short holdings.
Several other hedge funds suffered losses during that time period and made adjustments, such as reducing their shorting of individual stocks and instead betting against indexes or baskets of equities.
While Melvin made back some of the January 2021 losses last year, it suffered additional losses as growth stocks, a significant driver of stock-picking hedge funds’ returns in recent years, sold off in a market rout in early 2022. The selloff, brought on partly by the Federal Reserve’s moves to reverse its easy-money policies, hit former market darlings like Meta Platforms Inc., Netflix Inc., and PayPal Holdings Inc.
Faced with rising losses, Mr. Plotkin informed consumers in April that he intended to begin charging incentive fees before making his clients whole. He swiftly reversed his position, calling it “a mistake.” In May, he informed clients of his decision to return their funds, stating that he had been unable to produce the expected returns and that he needed to “move away from managing external capital.”
According to those familiar with the situation, Melvin’s continued losses made it impossible for him to come up with new terms that would be acceptable to clients while simultaneously incentivizing Mr. Plotkin’s team. The constant focus wore on Mr. Plotkin as well. According to those familiar with Mr. Plotkin, the probe had no bearing on his decision to return clients’ money.
Melvin was one of the highest-performing hedge funds until 2021 when it was founded in 2014 by Mr. Plotkin, a former top portfolio manager for Mr. Cohen.
Melvin’s track record fell from an average of 30% per year after fees from the fund’s inception in 2014 to 2020 to 11.9% from its inception to April 2022.
Clients who invested in Melvin at the beginning of 2021 had lost around 57% of their money by the end of May 2022, implying that Mr. Plotkin would have had to make more than 132% to make clients whole. According to a person acquainted with the situation, the majority of Melvin’s clients who invested after January 2021 gained money.
Professional investors remain wary of flare-ups in meme stocks, a concern that is fueled by moves like a gain of about 85% over the course of two trading days earlier this month in shares of Bed Bath & Beyond Inc.