Hedge fund information depository: a case study of a pre‐emptive solution to fund manager fraud

2021

JFC

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Purpose The purpose of this paper is events and analysis of present a hedge fund collapse, offer lessons to investors and hedge fund industry stakeholders and propose a possible remedy for mitigating operational risks and associated potential losses. Design/methodology/approach This study focused on one hedge fund case study and conducted a thorough investigation of the events that led to the collapse and eventual filing of the Securities and Exchange Commission (SEC) complaint. All articles and publications used for this research are available in the public domain and accessible. Findings Wood River Capital Management had concentrated the portfolios of its two hedge funds into one stock, EndWave Corp. Fund Manager violated terms of offering memorandum. Investors were not made aware of and did not discover the operational risks. Stock price of EndWave plummeted. There was no independent oversight over the funds. The values of the two funds dropped significantly. Investors attempted to redeem but the funds were not liquid. The SEC filed a complaint. Mr Whittier was sentenced for three years in jail. Research limitations/implications It is an analysis of US-based hedge fund, not an empirical paper. The article presents critical analysis and offers many valuable lessons to hedge fund industry stakeholders. Practical implications This paper helps investors in terms of identifying a hedge fund’s operational risks and conducting more effective due diligence while vetting a hedge fund. This could potentially save investors and constituents billions of dollars, by avoiding potential hedge fund collapses. This paper suggests that the scope of fiduciary duty be expanded to cover hedge fund industry vendors. Originality/value Thorough research of a hedge fund that collapsed because of poor investment decisions, not self-enrichment at expense of fund investors. This paper provides lessons to investors in terms of identifying a hedge fund’s critical operational risks and conducting value preserving due diligence. This could potentially save hedge funds investors billions of dollars, by avoiding potential hedge fund collapses. This paper recommends that the scope of fiduciary duty be expanded to cover hedge fund industry vendors.

“…These questions may have been answered had one or more hedge industry stakeholders launched and operated a hedge fund information depository as Muhtaseb (2009) proposed.…”

Section: Lessons and Questions To Stakeholdersmentioning

confidence: 99%

A hedge fund collapse and diversification 101: lessons to stakeholders

2021

JFC

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“…A prudent hedge fund investor or analyst would ask: how could these fraudulent activities been detected or prevented? To alleviate the risk of investment manager, Muhtaseb (2009) recommended for hedge fund industry stakeholders to start a hedge fund information depository where hedge fund industry stakeholders would provide (deposit) information on regular bases. The information depository serves as a clearing house that facilitates a long overdue timely communication network among hedge fund industry constituents.…”

Section: Introductionmentioning

confidence: 99%

Does the system reward investors for fraud risk? A clinical analysis

2021

JFC

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Purpose The purpose of this study is to show that despite the profound and commendable efforts of the SEC staff and many others in the legal system, aimed at combatting a billion-dollar hedge fund manager fraud, the perpetrators were effectively not held accountable for the unlawful conduct and hence did not bear the consequences of the conduct. This case highlights the presence of a significant risk that hedge fund investors are not fully accounting for and very likely not earning a commensurate premium for it. During the 1999–2002 period, Lauer and Associates inflated hedge funds’ valuations, misrepresented the holdings of the funds, shared fake portfolios with investors, did not provide reasonable basis for the excessive valuations of the investee companies and manipulated their security prices. In 2009, Lauer was found guilty of violating anti-fraud provisions of the federal securities laws and was ordered to pay US$18.9m in prejudgment interest and to surrender US$43.6m in ill-gotten gains. Despite the substantial evidence, on 11 April 2011 Lauer was acquitted in federal court, of wire fraud and conspiracy to commit securities fraud. Five other associates received light sentences. Yet investors were around US$1.0bn which were never recovered or compensated. Design/methodology/approach The study applies clinical case analysis. The study produced detailed research and analysis of the of the US based Lancer Management Group fraud case. The focus is on the consequences to investors and other stakeholders in the hedge fund industry. Findings In 2009, Lauer was found guilty of violating anti-fraud provisions of the federal securities laws and was ordered to pay US$18.9m in prejudgment interest and to surrender US$43.6m in ill-gotten gains. Despite the substantial evidence, on 11 April 2011 Lauer was acquitted in federal court, of wire fraud and conspiracy to commit securities fraud. Five other associates receive light sentences. Yet investors were around US$1.0bn. Investors’ losses were never recovered or compensated. Research limitations/implications This is a clinical case study. It is not an empirical study. Findings should be carefully construed. Practical implications This study directs hedge fund investors and industry stakeholder to the real possibility of not fraud but also to the limited efficacy of the system in terms of providing protection and compensation to investors. Investors and stakeholders must pay close attention in the due diligence process to minimize probability of fraud. Social implications Hedge fund industry fraud leads to devastating consequences to investors and obviously to their wealth and very possibly adversely impact local economy and community. Originality/value This study presents many events that show the extent of the fraud and how it was conducted. This paper shows despite the extensive effort of the regulatory and judicial system, the perpetrators of the fraud were not held accountable for their actions. This case does not point toward a macro system failure. It highlights the presence of a real risk that investors are not accounting for and very likely not earning a commensurate reward for it.

“…This article builds on the proposal made in Muhtaseb (2009) where a hedge fund information depository is presented as a possible vehicle for mitigating hedge fund fraud. Through a concise analysis of four hedge fund fraud cases our objective is threefold:draw lessons and conclusions for the hedge fund industry stakeholders;identify the key common key elements among the four fraud cases; andmost importantly, propose a solution that mitigates fraud risk.Part II presents the events that led to the fraud.…”

Section: Introductionmentioning

confidence: 99%

What is the consequence of the missing compliance function at hedge funds? Fraud is! Analysis, lessons and solutions

Journal of Investment Compliance

2010

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Purpose -The purpose of this paper is to offer case studies of hedge fund fraud, solutions that could mitigate hedge fund fraud risk, and a proposal for the industry to establish a hedge fund information depository (HFID) where participants/stakeholders could provide information on any hedge fund on regular basis.Design/methodology/approach -Four major hedge fund fraud cases, Bayou Funds, Lipper Holdings, Manhattan Investment Fund and Maricopa Investment Corporation are used as examples of the complete absence of independent oversight and the application of HFID.Findings -The paper finds that investors in the four funds lost more than $1.3 billion. In all four fraud cases, independent oversight and compliance function were conspicuously missing. In each fraud case there was at least one serious alert (warning) that took place at least 14 months prior to SEC first filing against the fund.Research limitations/implications -Some hedge fund industry stakeholders may reluctantly join HFID due to concern over possibly disclosing information deemed crucial for their own competitive advantage.Practical implications -Had third parties become aware of the alerts, they could have made a different investment or business decision. Most importantly, this depository would allow all hedge fund industry stakeholders (accountants, administrators, auditors, investors, marketers, prime brokers, custodians and regulators) to communicate with one another regularly.Originality/value -The paper makes two proposals: the founding of a hedge fund information depository; and outsourcing of the compliance function for hedge funds where it is more cost effective. Keywords Hedging, Fraud, Information strategy, United States of America Paper type Technical Then is one who walks headlong with his face groveling better guided -or one who walks with his head upright on a straight path? (The Holy Quran, 66:22).