New Twist on an Old Rule

Generally speaking, banks and other financial institutions extend themselves far beyond the amount of cash they actually have on hand. They keep just enough around to handle the normal influx of clients wishing to make withdraws. So there’s nothing scarier than an old fashion “run at the bank” and thats exactly what’s going on at many hedge funds these days…with a twist.

The latest hedge fund to undergo a rapid collapse is Sentinel Management Group, who describes itself as a “cash management firm.” Perhaps that’s a misnomer because once a few clients got wind of downward pressure on some of Sentinel’s investments, they started to pull out.

Apparently to fund the early redemptions, the firm made a deal with Citadel Investment Group, another secretive hedge fund. Citadel bought the most valuable of Sentinel’s investments at a major discount; some are saying as much as 30 percent.

Issuing more redemptions may have been a noble cause, but hedge funds have many different investors with different agendas. Institutional investors may have longer time horizons and are willing to sit through downturns, while high net worth individuals panic when their net worths are at stake. Such was the case with Sentinel Management. Several clients were large money management funds who didn’t take kindly to Sentinel selling its most valuable assets. Here’s the statement from one fund that had a stake in Sentinel:

"Based on what we have heard of the proposed terms, we believe that this sale occurred at discounts of up to 30% from market prices. This portfolio consisted of short term AA or better corporate bonds or US government agency bonds, as required under CFTC rules. We believe that to liquidate such a portfolio at such a discount to market value constitutes, among other things, a reckless disregard of industry fair practice responsibilities by all parties involved."

The lesson here is that an old fashion run on the bank has an equally damaging effect on hedge funds as it does on traditional banks. Furthermore, the Sentinel collapse shows that there are diverging interests at play and in seeking to appease one investor a hedge fund may be hurting another. The breaking news now is that the SEC will bring charges against Sentinel. The firm is accused of misrepresenting the true reasons for the collapse, which may not have been redemptions but excessive use of leverage.

Either way, the latest hedge fund collapse shows that the blood bath isn’t over on Wall Street. Bear Stearns, Goldman Sachs and many others likely to come show that the Wild West days are coming home to roost and investors are the ones taking the hit.

Trader Monthly Coverage

CNBC’s Charlie Gasparino wrote a great story on Zamansky & Associates in the latest issue of Trader Monthly. So good in fact that it was picked up by The New York Times’ reporter Andrew Ross Sorkin on his high profile blog: www.dealbreaker.com Here’s the direct link: A Plaintiffs’ Attorney Takes His Client List Upscale

Time to Reassess Your Hedge Fund Investment?

Ultra high net worth investors are understandably nervous these days about their investments in hedge funds. Whether they have a clear idea of how their money was invested or not, many are thinking it may be time to get out. More poignantly put by a guest today on CNBC, “if you don’t know what you are in, it might be time to sell.” As with any asset bubble, the dirty laundry gets aired when the market goes sour and the hedge fund industry has not escaped this trend.

For example, our clients who had investments in the collapsed Bear Stearns hedge funds allege that the fund managers misrepresented the quality of investments and risk controls in place. The troubles which allegedly surfaced when Amaranth lost a sizable chunk of its investor’s money revealed a trend known as “style drift;” when managers go outside of the fund’s stated strategy.

Unfortunately, when a hedge fund struggles often times investors are the last to know. This is because hedge funds are very lightly regulated and lack transparency. When they do struggle, a hedge fund managers’ interest is not always aligned with the investors’. The manager’s goal is to prevent a “run on the bank” and use his/her trading skills to get back to a profitable position. This is like the gambler who lost money at the black jack table but thinks the next hand will turn his luck around.

So what then, is an investor to do? Knowing redemption policies is a start. Many times an investor must inform the hedge fund of his/her intention to pull out of the fund in writing weeks ahead of time. In fact, many hedge funds require 45 days notice and redemptions are only available at the end of the month, therefore today is the earliest time a redemption can be requested. Today’s Wall Street Journal covered redemption policies and warned of pulling your money from a fund for fear of being sued by those who incurred losses by not getting out in time. This is a concern.

Secondly, investors should participate in every conference call, take notes and always ask the hard questions. Investors are entitled to honest information about a hedge fund’s investments, risk management and asset valuation methods. Investors should be extremely worrisome if any investment schemes drift away from the originally stated strategy. This could be indicative of troubled waters.

If a loss is incurred and the potential for misrepresentation and/or “style drifts,” or outright fraud exists, it’s important to act fast and consider contacting regulators and pursuing your own legal action. Sometimes the venue will be a settlement negotiation, while other times fund managers may be pursued via securities arbitration or the court system.

Remember, even wealthy investors have rights and fraud is illegal no matter who the victim is.

Bear Stearns Hedge Fund Update

Bankruptcy Judge Burton R. Lifland is scheduled to rule on August 27 where Bear Stearns’ two bankrupt hedge funds will be liquidated – in the Cayman Islands or New York.

Bear Stearns wants the funds liquidated in the Cayman Islands, where the funds were incorporated. But most of the assets of the funds are based in New York, so creditors may want the liquidation to take place in Lifland’s court.

Bear Stearns knows Judge Lifland quite well. The judge earlier this year ordered the firm to pay nearly $160 million to investors for failing to properly supervise Manhattan Investment Fund, one of the hedge funds it cleared trades for. Lifland also ruled that $121.1 million of transferred payments be returned to investors with interest. If Lifland decides to keep the case in his court, he could conceivably order Bear Stearns to return the millions of dollars in collateral it seized from its failed hedge funds before they collapsed.

Bear Stearns to Its Hedge Fund Investors: Walk the Plank

Today’s Wall Street Journal story on the continued unraveling of the Bear Stearns hedge funds include an easily overlooked item that deserves added scrutiny. When Wall Street executives outside of Bear Stearns pressured the firm to provide its two capsizing hedge funds with added liquidity, senior management initially balked. According to the Wall Street Journal, “Bear Stearns executives felt they shouldn’t feel obligated to lend money to a fund whose operations were separate from Bear Stearns’, and whose investors were knowledgeable about the risks.”

Forget for a second Bear Stearns’ apparent contempt for its clients, but one of the arguments we will be making on behalf of our clients who invested in these funds will be material misrepresentations of risks and investments: so investors were never truly “knowledgeable” in the first place.

Clearly rather than spend the money that usually goes into end-of-the-year bonuses, Bear Stearns preferred to throw investors overboard figuring these wealthy clients would land safely. But it doesn’t matter if you’re rich or poor, a sophisticated investor or not, you are entitled to honest information about your investments.

To view recent coverage of our case against Bear Stearns, please click here.

Spitzer’s Wall Street Playbook

If there’s one thing we can be assured of when it comes to Eliot Spitzer, it’s that he’s an intelligent man with a long memory. That would likely explain the announcement to put communications director Darren Dopp on “indefinite leave” in the wake of the Joe Bruno smear scandal.

Spitzer’s sacrificial lamb actually brings to mind the Wall Street executives who escaped Spitzer’s wrath for their mutual fund market timing practices by paying menial fines and scapegoating lower level employees. The dismissed employees, some of whom are my clients, were tagged as rogue traders and will likely never work in the securities industry again. After the dust settled, it was back to business as usual on Wall Street while Spitzer sought out the next headline.

Wall Street’s strategy for weathering the market timing storm wouldn’t have been lost on a shrewd guy like Spitzer, which is probably why Dopp was placed on “indefinite” leave and not fired outright. Spitzer, and maybe Dopp himself, likely thought that once the scandal ran its course that in time Dopp would come back under the tent. But there are a few key differences between Wall Street’s scapegoating and the Dopp dismissal. First off, Dopp was not a low level employee. Likewise Dopp can’t be tagged as a rogue since he’s been Spitzer’s right hand man since the “press not prosecution” days in the AG’s office. And finally, the smearing scandal has not turned the other cheek the way Spitzer’s market timing “investigation” did.

So this leaves Spitzer in a difficult position: does he risk a guy like Dopp, who knows where the bodies are buried, wandering off the reservation or does he re-ignite the scandal by re-hiring his long time foot soldier? Frankly, it doesn’t matter because either way Spitzer’s true colors will be exposed; he’s a politically motivated man who cares not what’s in the greater good so much as destroying the opposition. If the smear scandal cause irreparable damage to Spitzer’s political fortunes, he clearly has what it takes to make it as a senior Wall Street executive.