Manhattan Investment Fund sought to cover up or delay the inevitable consequences of its trading activities by issuing FALSE reports to its investors.
This led to the creation of an inflated track record, which allowed the hedge fund to bring in even more money, which in turn allowed them to pay off early investors with money from new investors. In other words a classic Ponzi scheme began.
Bear Stearns probably caught onto the scheme when one of its managing directors met an investor in the Manhattan Investment Fund at a party, and the investor talked about how his reports from the hedge fund showed a 20% return. The managing director understood from internal knowledge at the firm that the actual trades going through Bear Stearns were in with what the investor was reporting.
Bear Stearns did follow up with the hedge fund’s manager Michael Berger who is now a fugitive at large. Berger got out of the problem by telling Bear Stearns that Bear Stearns was one of only 8 or 9 prime brokers that the hedge fund was doing business with. In other words, we’re losing money with you as a prime broker, but not with the other prime brokers we deal with. It’s a great story, and even makes sense, but apparently Bear Stearns did not check out the story by calling the other prime brokers to see if it was true that the hedge fund was doing business with them as well.
Somebody at Bear Stearns figured something was amiss because months later, Bear asked the hedge fund to put up additional margin or cash in order to raise the margin requirement to 50% from 35%. The fund sent over another $141 million as margin payments. When the fund went out of business subsequently, Bear Stearns was secure, and did not suffer a loss.
Judge orders Bear Stearns to PAY
The bankruptcy judge controlling this case has ordered Bear Stearns to pay $160 million to the investors in the hedge fund. The judge’s ruling stated that Bear Stearns as prime broker, failed to properly supervise the fund’s activities prior to the 2000 collapse of the Manhattan Investment Fund.
This ruling is going to be appealed because to allow it to stand would create much greater risk for the prime brokerage industry than the industry feels it is being properly paid to manage. Bear Stearns only made $2.4 million in profits from the hedge fund’s activities, and now it is faced with a $160 million judgment.
What you the Investor need to know – Diversification?
If you are an investor in hedge funds, what you need to know is that any hedge fund can go belly up. That’s right, any of them. You cannot outthink someone who while running a hedge fund, is trying to defraud you. The only answer is DIVERSIFICATION in your personal investment structure. You must own an assortment of hedge funds if that is your investment vehicle choice, and not just one. Your funds should also use different investment strategies, and not just be equities long, or domestic, or any other classification.
Since you are searching for the elusive alpha (outsize returns), it your responsibility as an investor to be aware that fraud exists. Even just plain bad investment strategies can result in the loss of all your capital since these funds are using 6 to 1 leverage in the attempt to create performance.
You might also want to consider a FUND OF FUNDS vehicle. This is when you invest your money with a fund manager who makes no direct investments himself, but instead selects other hedge funds for you to be invested in. This involves a double layering of fees. If the returns are there for you year after year, than it doesn’t matter, but be careful, fraud does exist, and so do poor investment managers.
Goodbye and Good Luck
Richard Stoyeck
Article Source: http://www.articlerocket.com
Richard Stoyeck’s background includes being a limited partner at Bear Stearns, Senior VP at Lehman Brothers, Kuhn Loeb, Arthur Andersen, and KPMG. Educated at Pace University, NYU, and Harvard University, today he runs Rockefeller Capital Partners and StocksAtBottom.com Value Investing at StocksAtBottom.com/ez.html
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