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Category Archives: Hedge Fund Failures

Risky Business: Alternative Mutual Funds

Alternative mutual funds have exploded in popularity in recent years. But there is a dark side to alternative mutual funds. Last week, the Financial Industry Regulator (FINRA) warned investors about this very issue, cautioning them in an Investor Alert titled “Alternative Funds Are Not Your Typical Mutual Funds.” Among other things, the alert stressed the complex trading strategies and the unique characteristics and risks associated with alternative mutual funds.

“The strategies alternative mutual funds employ tend to fall on the complex end of the spectrum,” FINRA said in its Investor Alert. “Examples include hedging and leveraging through derivatives, short selling and ‘opportunistic’ strategies that change with market conditions as various opportunities present themselves.”

As their name implies, alternative mutual funds are quite different from their traditional counterparts. Alt funds typically use more exotic strategies, including options and leverage, as well as more complex asset mixes.  Alternative funds might invest in assets such as global real estate, commodities, leveraged loans, start-up companies and unlisted securities that offer exposure beyond traditional stocks, bonds and cash.

Some alt funds employ a single strategy. For instance, they may offer 100% exposure to currencies or distressed bonds. Some funds might employ a market-neutral or “absolute return” strategy that uses long and short positions in stocks to generate returns. Others may employ multiple strategies such as a combination of market-neutral strategies and various arbitrage strategies. Still others are structured as a fund containing numerous alternative funds or a special type of “fund of hedge funds,” according to FINRA.

Although the strategies and investments of alternative funds may appear similar to those of hedge funds, the two should not be confused, FINRA says. Alternative mutual funds are regulated under the Investment Company Act of 1940, which limits their operations in ways that do not apply to unregistered hedge funds. These protections include limits on illiquid investments; limits on leveraging; diversification requirements, including limits on how much may be invested in any one issuer; and daily pricing and redeemability of fund shares.

FINRA cautions investors who are considering investing in alternative mutual funds to carefully consider their investment objectives, performance history and fund manager of alternative funds before doing so.

FINRA Investigates B-Ds That Sold Variable Annuities With Investments in Hedge Funds

After clients saw $18 million in financial losses tied to variable annuities with subaccounts invested in hedge funds, the Financial Industry Regulatory Authority (FINRA) wants answers from the broker/dealers behind the sales.

As reported Dec. 5 by Investment News, the variable annuity was issued by Sun Life Financial Inc., while the two hedge funds were the Foresee Strategies Insurance Fund and the Foresee Strategies 3(c)(1) Insurance Fund LP. Both funds were related to a group called the SALI Multi-Series Fund LP.

The broker/dealers facing FINRA arbitration complaints from investors regarding the Sun Life annuities include: Geneos Wealth Management Inc., Lincoln Financial Network, National Planning Corp., SagePoint Financial Inc. and FSC Securities Corp.

Another broker/dealer that sold the product reportedly has been shut down.

Last week, a FINRA arbitration panel issued a $284,000 award to a SagePoint client, Phillip Sherrill, who filed a claim against the firm one year ago. In his complaint, Sherrill alleged actions of unsuitability, common law fraud, breach of fiduciary duty and negligence related to investments in the SALI Multi-Series Fund and the SALI Multi-Series Fund 3(c) (1) LP.

Hedge Fund Advertising: Opening Door to Investor Fraud?

Could a potential door for investment fraud be opening in the near future courtesy of the Jumpstart Our Business Startups (JOBS) Act? That very well may be the case unless the Securities and Exchange Commission (SEC) intervenes and comes up with new regulations to protect investors.

The JOBS Act was signed into law in April, with the idea to make it easier for small companies to raise capital. The law also allows private placements and hedge funds to advertise, for the first time, their products to the public.

As reported Dec. 4 by Bloomberg, the JOBS Act essentially means underperforming hedge funds can now market themselves with no serious restrictions or regulations regarding what they say or to whom they say it. In other words, some funds could easily tout themselves on the “airwaves, on websites and in the pages of the financial press to unsophisticated investors eager to get the same fabulous returns as the Wall Street elite,” the Bloomberg article said.

The potential risks to hedge-fund investors are considerable given the fact that the funds lack transparency, are extremely opaque and entail a compensation structure that encourages managers to bet big in order to claim their share of profits.

Moreover, many hedge funds hold thinly traded or illiquid investments, so investors are unable to easily withdraw their money.

The bottom line: Allowing hedge-fund advertising with no oversight attached does little to promote investor confidence in Wall Street. Indeed, it does the opposite.

Investor Claims Over ASTA/MAT Costing Citigroup Millions

Citigroup’s legal bills for arbitration claims from investors involving a failed group of fixed-income alternative funds known as ASTA/MAT keep growing. So far, the tally to reimburse investors who lost money in ASTA/MAT is some $85 million. And it could get even higher because more cases are scheduled for arbitration this year and next.

The ASTA/MAT funds lost some 90% of their value beginning in 2008. The funds, which investors say had been marketed as less risky and more profitable than other fixed-income and municipal investments, were highly leveraged and borrowed approximately $10 for every $1 raised. As the ASTA/MAT funds began to lose money, Citigroup managers continued to sell the products and employ highly speculative investment strategies.

Investors who have since filed arbitration claims with the Financial Industry Regulatory Authority (FINRA) allege that Citigroup and its managers intentionally misled them about ASTA/MAT and were well aware of the risks involved with the funds.

Internal Citigroup records and e-mails about ASTA/MAT appear to back up investors’ claims. As reported March 21 by USA Today, one such e-mail shows Citigroup had put an internal credit risk rating on ASTA/MAT at the highest and most volatile level possible.

“The biggest surprise is the damaging internal e-mails and the extent to which (Citigroup) people committed to writing that these were defective (investment) products,” said Steven Caruso, a partner with Maddox, Hargett & Caruso, in the USA Today article.

Caruso’s firm, along with the law firm of Aidikoff, Uhl & Bakhtiari, secured a $54 million judgment on April 11, 2011, for investors who suffered financial losses in Citigroup’s MAT/ASTA municipal bond funds and several other purported fixed income-related products. The award is the largest ever levied against a major Wall Street brokerage in favor of individual investors.

The ASTA/MAT funds have been the subject of an investigation by the Securities and Exchange Commission (SEC) for more than four years now. So far, details of that investigation have not been made public.

Meanwhile, investors like Ronald Beard keep waiting for an explanation. Beard and his family invested $400,000 in MAT/ASTA in 2007 on the recommendation of an advisor with Citigroup’s private banking arm. In the end, Beard lost almost all of his investment.

“We felt betrayed, and we were shocked,” Beard said in the USA Today story.

Christopher Puglisi of New Jersey also invested in ASTA/MAT in 2007 through an account at Citigroup’s Smith Barney division. He did so only after he was satisfied the money he invested from the sale of his trading business would be safe.

Instead, Puglisi lost more than $700,000.

ASTA/MAT Saga Continues

The Citigroup manager behind failed fixed-income alternative funds known as ASTA/MAT apparently is moving on with his life after the funds collapsed and left thousands of investors financially ruined.

As reported March 13 by Bloomberg, Reaz Islam ran the ASTA/MAT funds, which lost some 90% of their value in 2008. Since then, Citigroup has been the focus of a string of securities investigations, as well as lawsuits and arbitration claims filed by investors who contend the funds were marketed and sold to them as a safe, less risky and more profitable alternative than other fixed-income and municipal investments.

In reality, the ASTA/MAT funds were highly leveraged, borrowing approximately $10 for every $1 raised. Meanwhile, the managers of ASTA/MAT continued to invest in some of the most risky and speculative investment strategies possible. By February 2008, the funds had lost more than 90% of their value.

On April 11, 2011, an arbitration panel of the Financial Industry Regulatory Authority (FINRA) ordered Citigroup to pay a record $54 million to investors who suffered losses in ASTA/MAT and several other purported fixed income-related products. Investors in the case were jointly represented at the hearing by Steven B. Caruso of the New York City office of Maddox, Hargett & Caruso, P.C. and Philip M. Aidikoff & Ryan K. Bakhtiari of the Beverly Hills, California, office of Aidikoff, Uhl & Bakhtiari.

The ruling included an assessment against Citigroup of $17 million in punitive damages, following allegations that Citigroup misled investors about the risks of the funds. The award is one of the largest arbitration awards ever recovered on behalf of individual investors, according to FINRA.

 Meanwhile, Islam, who gave an interview to Bloomberg following a four-year silence on the ASTA/MAT matter, is now a managing partner with LR Global Partners LP. According to its corporate Web site, LR Global is a New York-based investment firm with operations in Bangladesh, Singapore,Vietnam and Sri Lanka.

As for Citigroup, the fallout from ASTA/MAT isn’t over. Arbitration claims for more than 69 households are still pending before FINRA for investors who are jointly represented by Maddox Hargett & Caruso, P.C. and Aidikoff, Uhl & Bakhtiari.

SEC Shines Spotlight on Crooked Hedge Funds

“Too-good-to-be-true” hedge funds are now undergoing intense scrutiny courtesy of the Securities and Exchange Commission (SEC) and a new computer system designed to analyze funds whose over-the-top performance could potentially indicate fraud.

The SEC began developing its computerized hedge fund analyzer in 2009; today it analyzes monthly returns for thousands of hedge funds. Officials at the SEC are keeping mum on exactly how the system works, but several civil-fraud lawsuits have been filed as a result of the effort.

One hedge fund that was sued by the SEC reported annual returns of more than 25% by allegedly overvaluing its assets, according to a Dec. 27 article by the Wall Street Journal. Another civil-fraud lawsuit involves ThinkStrategy Capital Management LLP and its Capital Fund-A hedge fund.

In 2008, Capital Fund-A reported a 4.6% return for the sixth year in a row. In comparison, the average hedge fund fell roughly 19% in 2008, with losses in eight of the year’s 12 months, according to data from Hedge Fund Research.

In a reality, Capital Fund-A hedge fund actually had a 90% loss in 2008, according to the lawsuit filed by the SEC against the hedge fund’s manager, Chetan Kapur.

As reported in the WSJ article, the SEC alleges that Kapur continued to report positive returns for the Capital Fund-A hedge fund even after it was liquidated and ceased trading in order to attract investors to his other funds. The SEC also claims that Kapur repeatedly inflated his firm’s assets under management in investor reports and invented a nonexistent management team.

Without admitting or denying wrongdoing, Kapur agreed to a lifetime ban from the investment industry. A federal court will later decide on penalties in the case.

Mat/ASTA Case Brings $54 Million Award For Investors

A highly leveraged municipal arbitrage fund known as Mat/ASTA has come back to haunt its creator, Citigroup Global Markets. On April 11, a Denver, Colorado-based Financial Industry Regulatory Authority (FINRA) arbitration panel awarded more than $54 million to two clients represented by the laws firms of Aidikoff, Uhl & Bakhtiari and Maddox, Hargett & Caruso.

The award includes punitive damages of $17 million and $3 million in attorney fees. The arbitration panel also assessed the entire cost of the arbitration hearing against Citigroup Global Markets, ordering the firm to pay $33,500 in expert witness fees and $13,168 in court reporter costs.

“This award demonstrates that even the most sophisticated investors were misled by Citi in the marketing and sale of the Mat and ASTA leveraged municipal arbitrage product,” said Steven B. Caruso of Maddox, Hargett & Caruso.

“The fact that the arbitrators also awarded expert witness costs, court reporter costs and all FINRA forum fees is both unusual and important,” Caruso added.

The Mat/ASTA fund was sold through Smith Barney and Citigroup Private Bank to high net worth clients between 2002 and 2007. According to investors, the returns and risks of the funds were represented as “slightly greater” than a typical municipal-bond portfolio.

In reality, the Mat/ASTA funds were highly leveraged, borrowing approximately $8 for every $1 raised.

“Citi misrepresented the known risks of Mat/ASTA to retail investors such as the claimants in this case,” said Dr. Craig McCann of Securities Litigation and Consulting Group. McCann served as an expert witness for the claimants.

Maddox, Hargett & Caruso continues to investigate FINRA arbitration claims on behalf of investors who suffered financial losses in leveraged municipal arbitrage investments, including Mat/ASTA.

Magnetar Hedge Fund Update

Documents from the Financial Crisis Inquiry Commission (FCIC) shed new light into the hedge fund Magnetar and its role in helping Wall Street create at least $40 billion worth of collateralized debt obligations and then betting against many of those same CDOs to fail.

Magnetar worked with most of Wall Street’s top banks in its deals – deals that ultimately produced millions of dollars worth of extremely toxic, high-risk investments. Among the banks that helped sell those toxic assets to investors: Merrill Lynch, Lehman Brothers, Citigroup, UBS and JPMorgan Chase.

A Jan. 27 story by ProPublica provides in-depth details on the latest findings from the FCIC’s investigation into Magnetar, which has consistently denied any involvement in selecting assets for the CDOs that it invested in and then often bet against.

The most recent report from the FCIC paints a different picture of truth, however. In its final report released on Jan. 27, the FCIC says Magnetar used a CDO called “Norma” to create a $600 million bet against mortgage-related securities. The CDO itself took the other side of the bet. As a result, investors in Norma ultimately lost hundreds of millions of dollars. And the investment bank that underwrote and marketed Norma to investors? Merrill Lynch.

In the FCIC report, Magnetar apparently made the selections without the knowledge of the CDO’s manager, NIR Capital Management. NIR was paid to manage the deal and was supposed to be independent of the investment bank and act in the interests of the CDO as a whole, according to ProPublica.

“When one Merrill employee learned that Magnetar had executed approximately $600 million in trades for Norma without NIR’s apparent involvement or knowledge, she e-mailed colleagues, ‘Dumb question. Is Magnetar allowed to trade for NIR?’”

The Merrill employee was one of the risk managers in charge of policing the firm’s CDO business.

“NIR abdicated its asset selection duties to Magnetar with Merrill’s knowledge,” the FCIC report states.

The e-mails regarding Magnetar’s asset selections for Norma came to light in a lawsuit between Netherlands-based Rabobank and Merrill Lynch. Once the e-mails and other documents were brought forth during discovery, Merrill Lynch settled the lawsuit for an undisclosed amount.

In the FCIC report, it was revealed that Magnetar received $4.5 million as part of the CDO’s “expenses.” Merrill Lynch, however, failed to disclose that fact to other investors, according to the FCIC. Magnetar’s own legal team explained the $4.5 million as “a rebate” on purchases made by the hedge fund.

Bear Stearns Criminal Trial Nears Conclusion

Ralph Cioffi and Matthew Tannin, the two former Bear Stearns executives who are on trial for allegedly lying to investors about the fiscal health of two hedge funds, will soon find out their fates. On Nov. 9, the month-long trial comes to a close, and a jury will begin deliberations on the charges of securities fraud, wire fraud, conspiracy and insider trading brought by the Office of the United States Attorney for the Eastern District of New York against the two men.

The charges against Cioffi and Tannin are tied to the management – and eventual implosion – of two Bear Stearns hedge funds known as the Bear Stearns High Grade Structured Credit Strategies Fund and the Bear Stearns High Grade Structured Credit Strategies Enhanced Leverage Fund.  Prosecutors contend Cioffi and Tannin told “black and white lies” to investors about the financial state of the two funds despite the fact they were seeing some of the worst market conditions on record.

Over the course of the past few days, prosecutors and defense counsel have presented their closing statements to the jury – and the differences in their approach are notable.

Assistant United States Attorney Ilene Jaroslaw provided the jury with a methodical chapter and verse of the mountain of lies and web of deception that resulted in more than $1.5 billion of investors’ capital being wiped out.  Meanwhile, counsel for Cioffi and Tannin responded in a way that can best be summarized as the “you should believe us and trust our interpretation of the facts because we’re Wall Street” defense.

Whether such a defense will resonate with members of the jury remains to be seen – as does the obvious question as to why Cioffi and Tannin chose not to testify in their own defense if, in fact, they had a plausible explanation for the explosive emails that are at the core of the government’s case.

We may never know that answer. But if we’ve learned one thing from the recent crisis on Wall Street, it’s this: When Wall Street tells us – either directly or through its hired guns – that we can and should trust it about anything, it’s a sure sign we need to button the pockets on the back of our pants and secure our wallets.  And fast.

Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

Banks Should Mark to Market, Contend Two Nobel Prize Recipients

Two Nobel laureates have entered into the valuation debate and are calling upon financial institutions to provide a more accurate portrait of their illiquid assets to investors. Robert Merton first commented on the issue in a column for the Financial Times on Aug. 18 in which he said banks that opposed mark to market accounting were simply looking to conceal depressed prices.

Myron Scholes echoed those comments in an Aug. 19 interview with Bloomberg, with both men urging banks to mark more securities to market and put any hard-to-value securities on public exchanges wherever possible.

According to Scholes and Merton, such a move would give investors better data on prices to more accurately reflect the value of an institution’s debt and equity securities.

Scholes and Merton shared the Nobel Prize for economics in 1997 for helping invent a model for pricing options. They also learned about the danger of leverage firsthand. Merton and Scholes were the creators of Long-Term Capital Management, whose collapse in 1998 was the largest-ever hedge fund failure at the time.

At one point, Long-Term Capital Management held more than $100 billion in assets. However, the firm was highly leveraged, borrowing billions to make big bets on esoteric securities. When the markets took a turn for the worse in 1998, the bets backfired and Long-Term Capital Management lost most its money. Fearing that its collapse could set off a full-scale market meltdown, the U.S. Federal Reserve stepped in to orchestrate a bailout by 14 lenders.

Ironically, there was only one naysayer among the 14 banks that agreed to the rescue: Bear Stearns.


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