Editor’s Note: Below is a comment authored by Jay Eisenhofer, co-managing director of investor law firm Grant & Eisenhofer, P.A. Views expressed are the author’s but this publication is grateful for the right to publish them. As always, reader responses are welcome.
When times were good, many hedge fund managers cultivated an image of Oz-like awe and invincibility. But recent revelations of bad behavior have left investors wary of those running the show.
It’s been a tough couple of years for institutional investors who placed their faith — and their cash — in the care of Philip Falcone, the founder of Harbinger Capital Management. While his hedge fund once reaped billions by betting against the US subprime mortgage market before the financial crisis, in recent years it has crashed to earth, thanks to Falcone’s gamble on a scheme to build a new wireless network, known as LightSquared, Inc., which filed for bankruptcy in May. From a peak of $26 billion in 2008, Harbinger Capital has dwindled to less than $3 billion, thanks to investment losses and withdrawals.
It turns out the pain was far from over for Harbinger investors. In June, the Securities and Exchange Commission sued Falcone, charging that he had broken the law to support his lavish lifestyle (which includes a 27-room Manhattan townhouse and private jet) at his investors’ expense. Among the allegations: Falcone borrowed $113 million from one of Harbinger’s funds in 2009 to pay his personal taxes without disclosing the loan to clients, or seeking their approval, effectively using the fund as his personal piggybank.
The SEC also charged that Falcone favored a few Wall Street institutions – including Goldman Sachs – above other investors and manipulated bond prices. “Today’s charges read like a final exam in a graduate course in how to operate a hedge fund unlawfully,” said Robert Khuzami, the SEC’s enforcement director, in a statement. “Clients and market participants alike were victimized.”
The sad news is that Harbinger’s investors are not alone in feeling dismayed, deceived and disgusted by the hedge fund industry’s dark side. Even as they continue to pour money into these vehicles — some 7,000 hedge funds are now estimated to hold $2 trillion in assets — many institutional and high net worth investors have grown wary of fund managers’ endless promises and relentless hype, thanks to a parade of well-publicized scandals that shows no signs of slackening.
Revelations of widespread deceptive practices – including bait-and-switch investment tactics, conflicts of interests, and severely mispriced assets – coupled with news of fund collapses and bankruptcies, and topped off by several years of sub-par investment returns, have left many hedge fund investors feeling sour and ripped off. Unlike the wave of recent insider-trading cases, like the one which sent Galleon Financial founder Raj Rajaratnam to prison earlier this year, the latest cases depict managers preying on their own investors.
Though the allegations against Falcone were outrageous, they are hardly unique. Consider:
· The SEC found that managers of Miami-based Quantek Asset Management deceived investors about their own stake in the $1 billion fund and failed to disclose self-dealing loans it had made to one of its managers, as well as to the fund’s parent company. “Quantek’s investors deserved better than the misleading information they received in marketing materials, side letters, and other fund information,” the SEC said. It ordered the fund to pay investors $3 million, and temporarily barred two fund principals from working in the security industry.
· In New York, investors filed a civil suit against Michael Balboa, manager of bankrupt Millennium Global Investments, claiming he had conspired to inflate valuations of emerging market debt by at least $80 million in marketing documents, in order to hide losses suffered in the 2008 meltdown and attract additional capital. Balboa faces a criminal complaint from US prosecutors and an SEC suit stemming from the same incident.
· In the UK, the Financial Services Authority fined Alberto Micalizzi, chief of Dynamic Decisions Capital Management $3 million for lying to investors in order to conceal the true value of the company’s master fund, which lost 85 per cent of its value — $400 million — during the last quarter of 2008. The FSA said Micalizzi continued to court new investors in the period leading up to the funds collapse in 2009. “Micalizzi’s conduct fell woefully short of the standards that investors should expect and behavior like this has no place in the financial services industry,” said an FSA official.