A Bay Area hedge fund manager has been charged with using $12 million in client funds for personal uses, including an investment in a record company.

The SEC complaint alleges Lawrence R. Goldfarb of Larkspur, Calif., and his company Baystar Capital Management LLC diverted the cash into other entities he owned and then lied to investors to cover up the scheme.

Without admitting or denying the SEC's allegations, Goldfarb and BCM consented to permanent injunctions against violations of certain provisions of the federal securities laws and to pay disgorgement of $12 million and prejudgment interest of $2 million, which will be distributed to the fund's investors.

"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.

The misappropriated funds were maintained in a "side pocket" into which investors in the hedge fund-Baystar Capital II LP-had limited visibility, according to the SEC. A side pocket is a type of account that hedge funds use to separate particular investments that are typically illiquid from the remainder of the investments in the fund. Goldfarb's side pocket investment became profitable in 2006, but he diverted the proceeds for his own uses-including funding for a SanĀ  Francisco record company-and covered it up for several years by sending investors false statements that reported no gains in the pocket, according to the SEC.

Goldfarb also comingled investor funds in a bank account that he used to pay for unauthorized personal expenses including entertainment and charitable donations, according to the SEC.

"Hedge fund managers may not use side pockets to obscure their activities from investors. 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," said Robert Kaplan, co-chief of the SEC Enforcement Division's Asset Management Unit.

The SEC alleges that Goldfarb also took steps to conceal the side pocket profits from the fund's third party administrator. For example, he directed money to the bank account of an entity that no longer existed.

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.