The Securities and Exchange Commission charged a hedge fund manager with diverting investment proceeds of over $12 million into other funds, which he then used to fund a real estate venture and a San Francisco record company.

On Wednesday the SEC charged Bay Area hedge fund manager Lawrence R. Goldfarb of Larkspur, Calif., and his company Baystar Capital Management LLC (BCM), with diverting investors’ proceeds to other entities he controlled. Goldfarb is also charged with pouring investor funds into a bank account that he used to pay for unauthorized personal expenses, including entertainment and charitable donations, according to the SEC complaint.

The SEC claims Goldfarb and BCM kept investor proceeds in a “side pocket” so investors in the hedge fund, Baystar Capital II, L.P., would have limited visibility of the funds. A side pocket is an account that hedge funds use to separate illiquid from liquid investments in the fund. Goldfarb’s side pocket investment became profitable in 2006, according to the SEC, at which time he is charged with diverting the proceeds instead of paying the fund’s investors. According to the SEC’s complaint, Goldfarb and BCM provided investors with false account statements for several years, showing no gains had been realized in the side pocket. The SEC claims that Goldfarb also tried to hide the side pocket profits from the fund’s third party administrator,  by directing money to the bank account of an entity that no longer existed.

Goldfarb and BCM agreed to pay more than $14 million to settle the SEC’s charges without admitting or denying the SEC’s allegations. The $12.1 million in disgorgement and $2 million in prejudgment interest will be distributed to the fund’s investors. Goldfarb also agreed to pay a $130,000 penalty, be barred from associating with any investment adviser or broker (with the right to reapply in five years), and be barred from participating in any offering of penny stock.

“Goldfarb betrayed the trust of his hedge fund’s investors, keeping them in the dark about their investment profits so he could use their money as his own,” said Marc Fagel, Director of the SEC’s San Francisco Regional Office, in a statement.

“Hedge fund managers may not use side pockets to obscure their activities from investors,” said Robert Kaplan, Co-Chief of the SEC Enforcement Division’s Asset Management Unit. “Hedge fund managers need to honor their obligations to investors, and investors should pay close attention to the discretion that managers wield over side pocketed investments.”