The Chatham Asset Management Case

American Media bonds traded over the counter and had few outside buyers. The next largest bondholder, the SEC found, attempted to sell during the relevant period and could find no purchaser other than a Chatham client. The market price looked external because trades passed through broker dealers and a pricing service published values, yet the underlying price formation remained heavily dependent on Chatham.

Some Chatham clients were liquid alternative funds: mutual funds that used hedge fund style strategies while allowing shareholders to redeem daily, and that imposed limits on exposure to a single issuer or industry.

The American Media positions created pressure inside those funds. A liquid alternative fund might need to sell bonds because investors redeemed shares, because the fund needed cash, or because the position exceeded an internal concentration limit. The need to sell did not mean Chatham had changed its investment view. The adviser still considered the bonds attractive and wanted another client to own them.

Chatham therefore arranged transactions in which one client sold American Media bonds and another client purchased the same securities. The SEC referred to these as rebalancing trades. From 2016 through 2018, Chatham used them to respond to redemptions, portfolio limits, and movements of capital across its clients.

Chatham recognized that registered investment companies faced restrictions on transactions with affiliated parties, including other clients managed by the same adviser, and it consulted a compliance adviser about how to execute the rebalancing trades. According to the SEC order, the recommended transaction format rested on a key condition: the trades needed independently derived market prices.

The SEC found that the economic process did not produce independent price discovery. One Chatham client would sell American Media bonds to a broker; Chatham would then purchase the same bonds for another client, sometimes the next day and sometimes through another broker. The brokers understood the intended sequence. The SEC found that Melchiorre told brokers Chatham would probably repurchase the bonds for another account, and that over time the arrangement became routine. When he wanted one broker to hold a bond overnight before a Chatham client repurchased it, the order describes him referring to the process as the "usual drill."

According to the SEC, the brokers often placed the bonds into inventory for a short period, and their willingness to do so depended on an expectation that Chatham would arrange the next purchase. Most did not seek buyers across the broader market; in nearly all cases, they resold the bonds to Chatham or to another broker acting for a Chatham account. Legal title passed through a broker, but the broker's economic role remained narrow: it held the security because it expected Chatham to bring the next buyer, and it generally did not solicit competing bids or accept meaningful market risk. The SEC found that Melchiorre proposed the transaction prices, that the brokers accepted them without first seeking bids from other participants, and that when Chatham repurchased the bonds it generally paid more than the selling client had received, with the increase compensating the broker or brokers involved.

Per the SEC order, legal title passed through a broker, but the broker generally did not solicit competing bids or accept meaningful market risk. Chatham had already arranged the expected buyer and proposed the price.

Chatham completed more than 100 rebalancing trades in the American Media bonds during the relevant period. The SEC found that those trades represented approximately 81 percent of customer trading in the securities on average, a market share that gave the activity substantial influence over observed prices.

The SEC found that Melchiorre considered the previous published price when proposing the next trade price, then added a spread to compensate the brokers. The published price itself reflected recent market transactions, many of which Chatham had arranged. A Chatham client sold a bond through a broker; another Chatham client purchased it at a slightly higher price; the completed trade entered the market record; a pricing service considered recent transactions when estimating the bond's value; and Chatham then referred to that published value when setting the next rebalancing trade. Each transaction provided support for the next one, and the market observation looked external after publication although Chatham had arranged most of the underlying trading.

The repeated increases caused American Media bond prices to rise faster than comparable securities. The SEC observed that by November 2017 two of the bonds traded through the rebalancing process at implied yields below the London Interbank Offered Rate, levels that would ordinarily be associated with bonds carrying much stronger credit quality. Bond prices and yields move in opposite directions, so a low yield suggests investors view the security as safer, yet the American Media bonds reached yield levels that did not fit their underlying credit profile. The prices reflected a market dominated by transactions among funds controlled by the same adviser.

The rebalancing trades created conflicts between Chatham clients at several levels. The selling fund needed liquidity and wanted the best available price; the purchasing fund needed fair value and protection against acquiring a security at a price unsupported by outside demand; and Chatham owed duties to both. Because the pricing service used trade data, one rebalancing trade could affect NAVs across the wider platform, so funds that did not participate in a trade could still receive a higher mark on their American Media holdings. Chatham also had an ownership relationship with the issuer, and the fee structure added a direct economic interest, since Chatham and Melchiorre benefited when higher marks increased management and performance fees.

The case depended on records that could have shown how the apparent market formed. Trade tickets would identify the selling client, purchasing client, broker, quantity, sale price, repurchase price, timing, and spread, and arranging those trades in sequence would show the repeated movement of the same bonds between Chatham accounts. Broker communications would show whether the bonds were offered to unrelated buyers, and whether brokers accepted meaningful inventory risk or participated because Chatham had already indicated an expected repurchase.

Market data analysis could separate Chatham related trades from outside transactions and compare prices from each group with yields on similar bonds; the unusually low yields reached by the American Media securities would then require explanation through credit fundamentals or independent demand. Pricing service files would identify which observations influenced each published value and test how much of the final mark came from Chatham arranged transactions. Fund NAV records would show how changes in the American Media marks affected each client's reported value, and fee calculations could then be recomputed after removing the price effects associated with the rebalancing trades. Allocation records would show why one client sold and another purchased, and whether the transaction served each client independently rather than a platform level objective of keeping the security inside Chatham managed accounts.

A trade executed through a broker can still lack independent price discovery. A value published by an external service can still depend on transactions controlled by the adviser. The calculation may be accurate; the input can still be compromised.

The due diligence problem concerned the quality and origin of the market evidence. A trade executed through a broker can still lack independent price discovery. A value published by an external service can still depend on transactions controlled by the adviser. An administrator can calculate NAV correctly while using a security price affected by conflicted trades. The calculation may be accurate. The input can still be compromised.

In April 2023, Chatham and Melchiorre settled SEC administrative proceedings. They agreed to the settlement without admitting or denying the findings, other than jurisdiction. The SEC found that their conduct caused client NAVs to be higher than they would have been without the rebalancing trades and resulted in excess fees, and that certain registered funds entered prohibited affiliate transactions. The SEC ordered Chatham and Melchiorre to pay $11 million in disgorgement, approximately $3.38 million in prejudgment interest, and $5 million in civil penalties, a total of approximately $19.38 million, and created a Fair Fund to distribute money to affected investors.

The Chatham matter documents a price formation problem inside a concentrated fund platform. Chatham clients owned most of an illiquid bond issue, and daily redemption needs and concentration limits required certain funds to sell. The SEC found that Chatham moved the bonds into other client accounts through brokers and proposed the transaction prices, that those trades became most of the customer market, and that a pricing service incorporated the resulting observations into bond values that entered fund NAVs and increased advisory fees. Rebalancing, broker execution, external pricing, fund administration, and fee calculation each performed a recognizable function, and Chatham's influence over the market linked them into a circular system. The resulting bond price carried the appearance of independent market evidence, while most of the activity behind that price came from Chatham moving the bonds among clients it controlled.