Founder And Portfolio Manager Of Canarsie Capital, LLC, Pleads Guilty In Manhattan Federal Court To Securities Fraud

Preet Bharara, the United States Attorney for the Southern District of New York, and Diego Rodriguez, the Assistant Director-in-Charge of the New York Field Office of the Federal Bureau of Investigation (“FBI”), announced the filing of an Information against OWEN LI, charging him with securities fraud and making a false statement, stemming from LI’s lies to investors and the U.S. Securities and Exchange Commission (“SEC”) regarding the performance of Canarsie Capital, LLC (“Canarsie”) – a hedge fund LI had founded and for which he acted as portfolio manager – which collapsed in January 2015.  LI surrendered this morning and pled guilty to the charges before United States Magistrate Judge Frank Maas shortly after the filing of the Information.

In a separate action, the SEC announced civil charges against LI and Canarsie.

U.S. Attorney Preet Bharara said:  “As Owen Li has now admitted, he lied to his investors and lied to the SEC.  His conduct led to crippling losses for his fund and its investors.  Crimes like Owen Li’s taint the entire marketplace and make honest investors wary of investing in securities markets.  Thanks to the investigative efforts of the FBI in collaboration with the SEC, Li will be held to account for his deception.”

FBI Assistant Director-in-Charge Diego Rodriguez said:  “Owen Li’s multiple unlawful actions as a trader finally caught up with him today as he pleaded guilty to securities fraud and making false statements. The FBI will continue to work with our partners in an effort at ensuring that our financial markets are legal, fair, and equitable.”

According to the two-count Information filed today in Manhattan federal court[1]:

LI founded Canarsie in January 2013 with approximately 10 investors and $16.55 million in assets under management.  By the end of 2013, Canarsie had approximately $47.75 million in assets under management, and LI earned over $2.2 million that year.  LI raised another $16.8 million in 2014, and at the time of its collapse in January 2015, Canarsie had approximately 41 investors and $56.8 million in assets under management.

According to Canarsie’s offering memorandum (the “Offering Memorandum”), which was provided to investors, Canarsie’s portfolio would be balanced and risk would be managed “through limits on position sizing and market exposure.”  Generally no position, whether long or short, would exceed 10% of Canarsie’s assets.

LI Reported Fictitious Trades to His Prime Broker

Canarsie reported Canarsie’s trades daily to its prime broker.  At the end of each trading day, the prime broker would match Canarsie’s trade report against trade reports submitted by executing brokers who had filled Canarsie’s orders that day.  Mismatches of information concerning trades reported by Canarsie and the executing brokers were considered “trade breaks.”

In March and early April 2014, LI began reporting fictitious “sell” trades to Canarsie’s prime broker at that time (“Prime Broker-1”) as if Canarsie had executed the trades, when, in fact and as LI knew, Canarsie had never actually sold the shares in question.  On April 9, 2014, Prime Broker-1 discovered multiple instances from March and early April 2014 in which LI had caused Canarsie to report trades that had not in fact been executed.  Specifically, Prime Broker-1 noted that LI had engaged in a pattern of reporting sell trades, particularly in shares of Facebook, Inc. (“Facebook”), to Prime Broker-1, and subsequently canceling the sell trades before the settlement date.

As LI knew, Prime Broker-1 calculated Canarsie’s margin requirement on the basis of trade date, not settlement date.  LI’s pattern of booking and cancelling “sell” trades temporarily created the false appearance that the long positions in Facebook and other stocks (and thus the leverage in the account) were diminishing.  This allowed Canarsie to (a) avoid a margin call from Prime Broker-1, and (b) avail itself of greater leverage than Prime Broker-1 ordinarily would have extended to Canarsie.  Therefore, on April 1, 2014, Canarsie’s account was levered approximately eight times, in that it was employing approximately $377 million of margin with equity of approximately $45 million.  In addition, LI had accumulated a position in Facebook that exceeded 10% of Canarsie’s total portfolio, in violation of the risk-management parameters set forth in the Offering Memorandum.

In light of those trade breaks, Prime Broker-1, among other things, forbade Canarsie from using margin and insisted that Canarsie hire a second prime broker, suggesting that eventually the second prime broker would become Canarsie’s sole prime broker in lieu of Prime Broker-1. In a meeting with a prospective second prime broker (“Prime Broker-2”), LI did not inform Prime Broker-2’s representatives that (a) Prime Broker-1 had told Canarsie to find a second prime broker, (b) Prime Broker-1 had withdrawn margin, and (c) if Canarsie established a relationship with Prime Broker-2, Prime Broker-2 would be, in essence, the sole prime broker for Canarsie.  In August 2014, Canarsie established a prime brokerage account with Prime Broker-2, and conducted virtually all of its trading through that account from that point on.

LI’s Misstatements to Investors About Canarsie’s Performance

At or around the end of each month, LI and others prepared and sent emails to Canarsie’s investors describing the fund’s performance.  Those emails contained an estimated net asset value (“NAV”) and monthly return.  Canarsie’s administrator (the “Administrator”) emailed each investor a monthly account statement showing the value of his or her investment and Canarsie’s NAV.  On at least two occasions, the estimated NAV supplied by LI and emailed to investors by Canarsie differed materially from the Administrator’s NAV, which appeared in the investors’ monthly statements.

In April 2014, Canarsie suffered approximately $13.6 million in losses and was down approximately 23% from the beginning of the month.  However, on or about April 30, 2014, LI falsely told at least one investor that performance was down only nine percent.  LI then intentionally delayed approving the correct April NAV, as calculated by the Administrator, because it was significantly worse than the NAV he had reported to investors at the end of April, and lied to investors about the reason for the delayed monthly statement and the reason for the discrepancy.

In December 2014, LI again delayed a monthly statement, this time for November 2014.  LI did not approve the preliminary November NAV because it showed losses the fund had incurred toward the end of November and trades that LI had deliberately broken and later canceled or amended.  Despite repeated requests from the Administrator, LI delayed approving the November NAV until January 8, 2015, falsely telling the Administrator that he had been in the hospital for a week.  LI also falsely told investors who inquired about the November statements that they were late because of staffing changes at the Administrator and the Administrator’s focus on preparing for the annual audit.

On January 9, 2015, LI instructed the Administrator to release the November 2014 statements to investors.  LI forwarded the statements to others at Canarsie, informing them that the fund’s November 2014 performance had been worse than the estimate Canarsie had provided to investors.  LI falsely told others at Canarsie that the discrepancy was due to a residual amount of money transferred from Canarsie’s account at Prime Broker-1 to the account at Prime Broker-2 on or about November 28, 2014, which was not credited to the account at Prime Broker-2 until December 2014.

LI Misled the SEC Examination Staff

On November 5, 2014, members of the SEC’s Office of Compliance Inspections and Examinations Staff (the “Examination Staff”) conducted a phone interview of LI and others at Canarsie.  Among other things, the Examination Staff asked why Canarsie appeared to be moving away from Prime Broker-1 as its prime broker, and conducting virtually all trading activity with Prime Broker-2.  LI responded that he had contacts at Prime Broker-2 from his prior employment and certain harder-to-cover stocks were easier to locate through Prime Broker-2 than through Prime Broker-1.  LI concealed from the Examination Staff that Prime Broker-1 (a) had withheld margin from Canarsie in or about April and May 2014, and (b) suggested that Canarsie move its prime brokerage relationship elsewhere.

On December 3, 2014, the Examination Staff again interviewed LI, and asked about the Facebook trades cancelled in or about April 2014.  LI responded that he had assumed that the brokers executed those orders, and had reported those trades to Prime Broker-1 as executed trades based on that assumption.  In fact, LI never placed or transmitted those orders to executing brokers.  LI concealed from the Examination Staff that he had fraudulently reported those trades as executions to Prime Broker-2 in an effort to conceal the extent of leverage in the fund and the size of the position in Facebook.

LI Caused Catastrophic Losses in the Fund

In December 2014 and January 2015, LI concealed from investors and others at Canarsie the fact that he was trading the fund in violation of the investment mandates in the Offering Memorandum and that, in doing so, he had placed the fund at excessive risk of catastrophic loss.

The fund’s net account value on or about December 31, 2014, was approximately $59.7 million.  Beginning in early January 2015, LI began liquidating the equity long positions in the account – resulting in approximately $18 million in losses – and eliminated all short positions in the fund.  At the same time, LI bought short-dated long positions in market index options.  The result was an entirely long, unhedged portfolio.

On January 16, 2015, index options prices moved against Canarsie’s positions, resulting in losses of approximately $39 million.  At the end of the day on January 16, the account was left with no equity, short, or options positions.  As a result of LI’s trading, the fund lost substantially all of its assets between on or about December 31, 2014, and on or about January 16, 2015.

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LI, 29, pled guilty to one count of securities fraud and one count of making a false statement.  Count One carries a maximum sentence of 20 years in prison.  Count Two carries a maximum sentence of five years in prison.  The charges also carry a maximum fine of $5 million, or twice the gross gain or loss from the offense.  The maximum potential sentences in this case are prescribed by Congress and are provided here for informational purposes only, as any sentencing of the defendant will be determined by the judge.

Mr. Bharara praised the work of the FBI, and thanked the SEC for its assistance.

The charges were brought in connection with the President’s Financial Fraud Enforcement Task Force.  The task force was established to wage an aggressive, coordinated and proactive effort to investigate and prosecute financial crimes.  With more than 20 federal agencies, 94 U.S. attorneys’ offices, and state and local partners, it is the broadest coalition of law enforcement, investigatory and regulatory agencies ever assembled to combat fraud.  Since its formation, the task force has made great strides in facilitating increased investigation and prosecution of financial crimes; enhancing coordination and cooperation among federal, state and local authorities; addressing discrimination in the lending and financial markets; and conducting outreach to the public, victims, financial institutions and other organizations.  Since fiscal year 2009, the Justice Department has filed over 18,000 financial fraud cases against more than 25,000 defendants.  For more information on the task force, please visit www.StopFraud.gov.