SEC Probing Melvin Capital Disclosures

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by Tyler Durden
Thursday, Aug 11, 2022 - 05:38 PM

After his catastrophic 2021 performance, when he lost billions to an army of short-squeezing retail apes, and just as gruesome returns in 2022, which prompted Melvin Capital's Gabriel Plotkin to try a desperation Hail Mary attempt to strip the high water mark from his fund (which naturally failed) and then forced the former SAC Capital "information arbitrageur" to shutter his highly overrated hedge fund, Plotkin was hoping he could go on a lengthy sabbatical in his recently renovated Miami mansion, take a couple of years off, then make a valiant return into the asset management business. After all, Americans love an underdog.... well, maybe with one exception: the SEC.

The WSJ reports, citing "people familiar with the matter", that the Securities and Exchange Commission is looking into Melvin Capital Management's risk controls and investor disclosure after the hedge fund was crippled by the meme-stock rally last year. As a reminder, Melvin lost $6.8 billion in January 2021, or more than half its assets under management, as retail and other investors banded together to target the fund's short positions. The meme-stock frenzy died down by the end of January and Melvin raised new money from investors.

The regulator has reportedly contacted investors in the hedge fund in recent months (our condolences to all of them), as part of an investigation into what Melvin founder Gabriel Plotkin and other senior executives told them in the wake of the meme-stock rally in January 2021, and whether it misled investors when it raised money last year.

Already the SEC has reportedly obtained from Melvin, which has largely returned its clients' money, its general communications with investors and has sought information about what the firm disclosed about the risks of its investment strategy to clients.

The investigation is in its early stages and may not lead to any formal claims of wrongdoing. It is being handled by the enforcement division's asset-management unit in Washington, D.C., the people said. The SEC and other law-enforcement authorities have investigated the frenzied trading in early 2021 that sent shares of GameStop Corp. and others soaring.

Plotkin and other executives told clients in virtual meetings that he planned to soldier on and that the firm had strengthened its risk-management practices after surviving an unforeseeable market phenomenon, clients said. Several other hedge funds sustained losses during that period and made adjustments thereafter.

Remarkably, while Melvin made back some of the January 2021 losses last year, it suffered additional losses as growth stocks sold off in the market rout earlier this year. Plotkin surprised investors in May by announcing he was returning their money. He told clients he had been unable to deliver the returns they should expect and recognized he needed "to step away from managing external capital."

As Melvin was pummeled anew by the selloff in technology and other fast-growing companies this year, Plotkin attempted to start charging incentive fees before making his clients whole. He quickly backtracked from that proposal, calling it "a mistake," then told clients of his decision to return their money. Continuing losses made it difficult for Melvin to come up with new terms palatable to clients that also would motivate Mr. Plotkin's team, said people familiar with the matter. The continued spotlight also wore on Mr. Plotkin.

The rise and fall of Melvin Capital is a case study in confusing investing talent with chasing beta: founded in 2014 by Plotkin, a former top portfolio manager for hedge-fund titan Steven A. Cohen best known for being kicked out of the industry for almost a decade due to pervasive insider trading using expert networks and every other means possible, Melvin was one of the top-performing hedge funds until 2021.

And then it all blew up when a handful of angry retail trading "apes" launched a concerted short squeeze on Melvin's biggest shorts (an attack which was coordinated by another hedge fund, Senvest). As a result of the catastrophic 2021, Melvin's track record collapsed from an average 30% a year after fees, from the fund's start in 2014 through 2020, to 11.9% from its inception through April 2022. Of course, anyone who invested in the fund recently, like in Jan 2021 for example, lost more than half their money. Indeed, as the WSJ calculates, by the end of May 2022, clients who were invested in Melvin at the start of 2021 had lost about 57% of their money, meaning Mr. Plotkin would have had to make more than 132% to make clients whole.

Our advice: don't feel too bad for young Gabe: as the following photo tour of his new $32 million Miami mansion shows, he'll be fine even if he has to do a few months in minimum security.