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Tuesday, October 16, 2007

Bear Stearns Hedge Fund Collapse: A Veritable House of Cards

When I first disclosed in June that I planned to file investor claims against Bear Stearns and the managers of the firm’s High-Grade Structured Credit Strategies fund and High-Grade Structured Credit Strategies Enhanced Leverage fund, some pundits were immediately skeptical. They reasoned that investors should know that hedge funds are inherently risky – pay your money, you take your chance, as the saying goes. You shouldn’t seek legal redress for a bet that goes south.

Yes, there were some cryptic warnings mentioned in the fine print of the Bear hedge fund prospectuses. But many investors were deceived into believing they were actually investing in reasonably conservative funds that had the full faith and backing of the investment bank. My office has obtained documents clearly showing that investors were told the fund would be protected from market downturns through “high-quality investments.”

The Bear hedge funds were anything but conservative. Their horrific collapse is impressively chronicled in this week’s newly designed BusinessWeek. In their impressive, easy-to-understand narrative of a highly complex subject, reporters Mathew Goldstein and David Henry explain how the Bear funds should have been more aptly named “The Wing and the Prayer” funds. More than 60% of their net assets were fair valued by management – meaning they were worth what management said they were worth, not what they could necessarily fetch if there were actual buyers for the securities. (In many instances the assets were so obscure there wasn’t a ready market for them).

The growing trend of valuation abuse to goose returns to garner higher performance fees or prevent redemptions is more practiced than Wall Street would have you know. One of the paragraph’s in the BusinessWeek article says it all:

Valuation games are surprisingly common. A study this summer by Riskdata, a hedge fund risk consulting group, found that at least 30% of hedge funds that rely on illiquid trading strategies are "smoothing returns" to make a fund's performance appear less risky by evening out month-to-month volatility. The study, which was published in June, included the Bear funds among those it examined. "The Bear Stearns hedge funds had a profile that's typical of funds that smooth earnings," says Olivier Le Marois, Riskdata's chief executive officer. "Smoothing returns is very misleading."

BW also does an excellent job of highlighting an unusual – and little understood -- arrangement the Bear funds had with Barclays, which conflicted with the interest of many allegedly unknowing investors. With the advantage of hindsight, the Strategies Fund mission statement was clearly a joke.

Bear Stearns Asset Management Inc. (“BSAM®”) is focused on high value added investment solutions that span traditional and alternative assets for institution and high net worth investors. We are committed to providing our client with world-class investment management and thorough communication of both risks and returns.

Sadly, investors who trusted Bear Stearns and invested in their hedge funds aren’t the ones who are laughing.


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