Hedge Funds Under Fire

Bear Litigation Could Hit Bienen

Bond Fund Costs Schwab More Than $500,000

Hedge Fund Losses Could Lead to Style Drift

Reuters reports on key indexes pointing to large losses by hedge funds in the month of July - and likely for the foreseeable future. The reasons are that many hedge funds that were highly leveraged are receiving margin calls. And a great many firms are being hammered by a combination of falling commodity prices and rising financial stocks, which pressured popular bets in the opposite directions.

As liquidity dries up and prime brokerage lines shrink, we are likely to see more hedge fund managers going outside the box and making riskier, more speculative plays. If these investments diverge from the style or strategy disclosed to investors when they joined the hedge fund, more and more lawsuits based on style drift and fraud (failure to disclose) could be filed by investors.

Investors are entitled to a certain amount of transparacy based on the originally disclosed investment strategy - if the strategy changes, investors should be given an opportunity to either withdraw or consent. Simply baiting and switching is unacceptable and likely will lead to lawsuits. Amarath is viewed as exhibit A. The fund said it was employing a presumably safer multi-strategy approach, but in fact the managers made huge bets in natural gas.

One of the major differences between a claim against a hedge fund and a claim against a brokerage firm is that in many instances the hedge fund investors must file the lawsuit in court instead of through FINRA’s arbitration proceedings. On the surface that is a disadvantage, but given hedge fund managers propensity for secrecy, such a public dispute could lead them to act quickly and make investors whole.

It’s a Long, Cold, Cashless Siege

Bear Stearns & Ralph Cioffi: Breaking Up is Hard to Do

We’ve obtained the termination “Form U-5″ filed by Bear Stearns regarding the now departed portfolio manager, Ralph Cioffi, who guided the two hedge funds specializing in investing in mortgage backed securities into the abyss. My prior blog post anticipated this filing.

The document discloses Cioffi left the firm under a “mutual agreement” with Bear Stearns effective November 28, 2007. The U-5 further states that in June 2007 the firm initiated an internal investigation into Cioffi’s “role and conduct” in the failed funds and that “in addition, Federal and state regulators and law enforcement are also investigating” the same hedge funds and “similar issues”.

Bear Stearns clearly wanted an amicable departure. Often when firms are under investigation they look to scapegoat others. In this instance, Bear Stearns has a strong interest in keeping Cioffi “on-the-reservation” given the firm’s exposure to allegations of fraud in criminal and civil proceedings. The firm stands to benefit so long as their interest and Cioffi’s are aligned. Therefore Bear Stearns doesn’t have any incentive to include “negative” disclosures which could shed light into how the hedge funds collapsed.

This is stark contrast to allegations that Wall Street firms use Form U-5 to defame departing employees in order to scapegoat them for firm-wide wrongdoing or prevent them from competing on a fair level. I actually have clients that allege Bear Stearns did just that when the firm struck a $250 million settlement with the SEC over mutual fund market timing. The sordid tale was chronicled by Forbes in a story entitled “Fall Guys”.

The message is that on Wall Street, you get the “kid-glove” treatment if you’re either a Wall Street CEO, or as with Cioffi, the firm needs a friend for upcoming litigation.