CFTC charges LJM with commodity pool fraud in connection to risk profile

Rick Steves

In January 2018, LJM had over $1 billion in assets under management, but a month later it lost over 80% when the CBOE’s VIX spiked over 20 points and, shortly thereafter, LJM closed its business.

The Commodity Futures Trading Commission has charged Chicago commodity pool operators (CPOs) LJM, their Chairman Anthony J. Caine and Chief Portfolio Manager Anish Parvataneni with commodity pool fraud and fraud in connection with options on futures contracts.

The regulator claims the firm and its heads made false or misleading statements about worst-case losses, risk management, and LJM’s risk profile.

According to the complaint, in January 2018 LJM had over $1 billion in assets under management, but on February 5 and 6, 2018, LJM’s portfolios suffered large trading losses (over 80%) when the Chicago Board Options Exchange’s Volatility Index (VIX) spiked over 20 points and, shortly thereafter, LJM closed its business.

The complaint alleges LJM represented that the worst-case scenario for its strategies was a maximum daily loss of 20% for P&G, 30% for Moderately Aggressive and 35-40% for Aggressive as calculated from LJM’s internal historical scenario analysis (i.e. events like Lehman Bros collapse 2008, Flash Crash 2010, and S&P downgrade of U.S. debt 2011).

This representation was false because the worst-case scenarios were not based on historical scenarios, and LJM’s internal historical scenarios showed losses much greater than 40% for each strategy, according to the complaint.

The complaint alleges that, by late 2017 through February 2018, LJM had significantly deviated from its historical risk profile, in that the delta had moved from negative to consistently positive, vega decreased, gamma decreased and the portfolio’s vulnerability to loss in certain scenarios more than doubled.

Acting Director of Enforcement Vincent McGonagle, said: “It is imperative that all participants in our markets receive full disclosure of material information and protection from fraudulent practices. When companies or individuals make false or misleading statements about the risks of trading, or fail to diligently supervise their employees or agents’ activities relating to their business as CFTC registrants, the CFTC will seek to hold them accountable.”

The CFTC also issued an order filing and settling fraud charges against LJM’s former Chief Risk Officer and registered AP of LJM, Arjuna Ariathurai and requiring him to pay a civil monetary penalty of $150,000, disgorgement of $83,333, along with pre-judgment interest of $14,111, and to cease and desist from further violations.

In parallel actions, the Securities and Exchange Commission today announced similar charges against LJM.

LJM responds to the SEC and CFTC charges

Anthony “Tony” Caine, Founder and Principal of LJM Funds Management, Ltd. (“LJM”), today issued the following statement in response to enforcement actions brought against LJM and its principals by the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”) in the U.S. District Court for the Northern District of Illinois:

“We categorically deny all of the SEC’s and CFTC’s assertions, have summarily rejected their respective settlement offers and will vigorously defend ourselves. We will demonstrate that risk of loss was fully disclosed, LJM did not deviate from historic portfolio and risk management practices, and the losses sustained on February 5-6, 2018 occurred as a result of events outside of LJM’s control.

“The suggestion that LJM committed fraud has no factual basis and is undermined by the fact that I personally lost over $100 million on February 5-6, 2018, and LJM portfolio managers invested more than $500,000 new capital on February 1, 2018 in the same funds as LJM investors.

“The event known as Volmageddon that caused the collapse of multiple investment firms involved a single-day increase in the VIX Index of 20.01 points or 115%, more than double the previous largest single-day percentage move. According to analysis by Integritas Financial Consulting, this increase was a 13.7 standard deviation event, or the equivalent to the probability of the same person being hit by lightning 1,000 times.

“During the SEC and CFTC’s three-year investigation that included a dozen full day interviews of LJM officers and employees, neither regulator ever asked the most important question: What caused the losses? LJM presented extensive and compelling data indicating that VIX manipulation was the primary cause of the losses, further exacerbated by FCM system failures and improper FCM forced position liquidation. LJM is pursuing financial recovery for its investors in lawsuits pending in federal court in Chicago and New York.

For twenty years, LJM compiled an impressive track record of annualized returns ranging from 9% to 18% for its three core funds. Prior to Volmageddon, LJM successfully managed through multiple periods of extraordinary market volatility, including the 2008 financial crisis.

“It is highly ironic that the SEC and CFTC are now filing claims against LJM, which was harmed by their failure to oversee markets and prevent manipulation in VIX and SPX options markets.”

“We will vigorously defend these false claims while continuing to aggressively pursue actions to seek financial recourse for LJM investors.”

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