Melvin Capital’s risk controls under SEC investigation

The US 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, said people familiar with the matter.

The regulator has contacted investors in the hedge fund in recent months 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.

The SEC has 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 people said.

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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 DC, the people said. The SEC and other law-enforcement authorities have investigated the frenzied trading in early 2021 that sent shares of GameStop and others soaring. It couldn’t be learned whether the broader inquiries are related to the SEC’s probe of Melvin.

Melvin lost $6.8bn 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.

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.

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 recognised he needed “to step away from managing external capital.”

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People familiar with Plotkin said the investigation didn’t play a role in his decision to return clients’ money.

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 Plotkin’s team, said people familiar with the matter. The continued spotlight also wore on Plotkin.

Founded in 2014 by Plotkin, a former top portfolio manager for hedge-fund titan Steven A. Cohen, Melvin was one of the top-performing hedge funds until 2021.

Its recent travails took Melvin’s track record 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.

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 Plotkin would have had to make more than 132% to make clients whole. Most of the clients who invested in Melvin after January 2021 made money, a person familiar with the matter said.

Write to Juliet Chung at [email protected], Susan Pulliam at [email protected] and Dave Michaels at [email protected]

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