The Financial Services Authority (FSA) has published decision notices against the bosses of Arch Financial Products, which ran the Arch Cru funds.
It said it would have fined Arch £9 million were it not for the firm's financial position.
The FSA said that Arch was 'reckless' as to the risks of conflicts of interest in its management of the funds. It pointed to one transaction where Arch received a fee of £3 million from the Guernsey-listed cell companies that made up the Arch Cru funds, but did not disclose that fee to the cell directors.
It added that Arch pursued an investment strategy which resulted in significant liquidity risks for the funds, investing the majority of the Arch Cru funds' assets in the Channel Islands cells, where there was a limited secondary market, even at times of market turbulence and illiquidity.
The regulator argued that Arch and its former compliance officer Addison adopted 'an informal, ad hoc approach to compliance monitoring with insufficient recording of the monitoring that was undertaken'.
Arch, Farrell and Addison have referred their cases to the Upper Tribunal. The FSA added that Arch, Farrell and Addison had applied to the tribunal for an order preventing the FSA from publishing the decision notices, but that the applications were not successful.
Tracey McDermott, director of enforcement and financial crime, said: 'When making investment decisions, a fund manager should ensure that it puts investors’ interests ahead of its own and be able to demonstrate that it has managed conflicts of interest.
'Those with responsibility for managing authorised firms must ensure not only that the firm complies with regulatory requirements but also that they personally act with the highest standards of integrity.'
Arch said in a statement: 'We fundamentally disagree with every aspect of those notices and now look forward to the opportunity to set matters straight in the Upper Tribunal.' It added that delays in the FSA's investigation meant the regulator could be time-barred and not able to enforce its decisions.