The Lawyer, the Professor and the hedge fund fraud

Another day, another scandal. The SEC yesterday froze the assets of a Texas based PrivateFX Global One Ltd. after charging the firm with fraud. Specifically, the charges state that Robert D. Watson and Daniel J. Petroski, allegedly forged bank statements to inflate returns. The strategy managed by the firm was ironically called “Alpha One” and claimed to generate profits through their proprietary foreign-currency trading software program that they called “Alpha One.” The CFTC has filed similar charges.

Mr. Watson resigned last month from Texas A&M, where he had been an Executive Professor of Finance at the Mays Business School. Looks like he submitted his resignation a bit too soon. Mr. Petroski is both a lawyer and a certified public accountant. It is reported that the firm had raised approximately $19 million from investors.

Echoing signs of Madoff the firm allegedly told investors that it never had a losing month and returned an annual 23%. Interestingly Watson and Petroski are also accused of creating phony account statements and records for SEC investigators. Obviously, they were not phony enough to fool the SEC.

This is a classic case where basic due diligence, asset verification and independent custody would have been key elements in preventing a fraud. There is nothing inherently wrong with black box FX trading models run by professors with snazzy names but investors need to look past the smoke and mirrors. Here’s a simple rule that has gained acceptance in recent months - if a hedge fund manager cannot break down their strategy in plan simple terms to explain how they are making money don’t invest – period.

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