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Article
Publication date: 6 April 2021

Majed R. Muhtaseb

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…

Abstract

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.

Details

Journal of Financial Crime, vol. 28 no. 3
Type: Research Article
ISSN: 1359-0790

Keywords

Article
Publication date: 11 August 2021

Majed R. Muhtaseb

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…

Abstract

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.

Details

Journal of Financial Crime, vol. 28 no. 4
Type: Research Article
ISSN: 1359-0790

Keywords

Article
Publication date: 2 July 2018

Majed R. Muhtaseb

The purpose of this paper is to draw lessons to investors from the conduct of a hedge fund manager who according to the Securities and Exchange Commission (SEC) complaint…

Abstract

Purpose

The purpose of this paper is to draw lessons to investors from the conduct of a hedge fund manager who according to the Securities and Exchange Commission (SEC) complaint made false and misleading statements before and after an auditor’s reports, misappropriated for personal benefit over $1m, misappropriated clients’ assets, failed to conduct due diligence on third-party buyer, instructed an employee to mislead investors and satisfied some investors’ redemptions with other investors’ subscriptions (Ponzi scheme) without disclosing it to investors. Ironically, the scheme was unveiled by the economic crises and not the investors, their advisers or third-party hedge fund vendors. Corey Ribotsky set up the investment adviser NIR Group to manage four AJW Funds that invested in private equity in public companies in 1999. Through manipulation of financial statements, he also managed to collect about $136m in management and incentive fees over an eight-year period. The SEC complaint alleged the AJW Funds’ assets to be $876m in 2007, yet this figure was not verified, and no assets were traced. Ribotsky did not pay any monies to SEC, as ordered by court settlement, and hence the victims did not recover any of their monies. The SEC could not produce criminal charges; hence, Ribotsky did not go to jail. This case highlights sterility of law enforcement when confronted with brazen fraud.

Findings

Investors fail to monitor hedge fund managers. Fraud was detected late and not through investors. Fraud was unraveled by the economic crises of 2008. The SEC had sued the fund manager. The fund manager consented to making payment to the SEC but did not make any payments. The SEC could not bring evidence to criminally charge the fund manager.

Research limitations/implications

The findings based on the case study are valuable to investors and hedge fund industry stakeholders. The findings are not based on an empirical study.

Practical implications

Investors need to carefully vet all hedge fund managers before allocating and funds and understand how managers make money through the claimed strategy. Also, there are limitations to law enforcement even with confronted with profound fraud schemes.

Originality/value

The case was built up from public sources to benefit investors considering making allocations to hedge fund managers. The public information about the case is of either legalistic or journalistic in nature.

Details

Journal of Financial Crime, vol. 25 no. 3
Type: Research Article
ISSN: 1359-0790

Keywords

Article
Publication date: 3 February 2020

Majed R. Muhtaseb

The loss of an amount in excess of $100m cash deposit can be disruptive to the operations, definitely the liquidity of the hedge fund. Should a hedge fund liquidity…

Abstract

Purpose

The loss of an amount in excess of $100m cash deposit can be disruptive to the operations, definitely the liquidity of the hedge fund. Should a hedge fund liquidity position deteriorate, its compromised solvency could impact its vendors, most notably creditors and prime brokers. Large successful hedge funds do make basic mistakes. Lawyer Marc Dreier committed the criminal act of selling fraudulent promissory notes to hedge funds and others. Mr Drier’s success in selling fraudulent promissory notes was facilitated by his accomplices who posed as fake representatives of legitimate institutions. Drier and team presented bogus “audited financial statements” and forged developer’s signatures, and even went as far as using the unsuspecting institutions’ premises for meetings to meet potential notes buyers to further falsely legitimize the scheme. He had the notes buyers send their payments to his law firm account, to secure the money. His actions cost his victims, who include 13 hedge fund managers, other investors and entities, $400m in addition to his law firm’s employees who also suffered when his law firm was dissolved. For his actions, he was sentenced 20 years in federal prison for investment fraud. This study aims to direct hedge fund investors and other stakeholders to thoroughly vet the compliance function, especially controls on cash disbursements, even if the hedge fund is sizable (in excess of $1bn). Investors and even other stakeholders also should place a greater focus on what is usually overlooked issue; most notably the credit quality and authenticity of short-term investments bought by their hedge funds.

Design/methodology/approach

A thorough investigation of a fraud committed by a lawyer against a number of hedge funds. Several important lessons are identified to professionals who conduct due diligence on hedge funds.

Findings

The details of the case are very remarkable. This case directs investors’ attention to place greater efforts on certain aspects of operational risk and due diligence on not only hedge funds but also other investment managers. Normally investors conduct operational due diligence on the fund and its operations. Investors also vet fund external parties such as prime brokers, custodians, accountants and fund administrators. Yet, investors normally do not suspect the quality of short-term fund investments. In this case, the short-terms investments were the source of unforeseen yet substantial risk.

Research limitations/implications

Stakeholders in hedge funds need to carefully investigate the issuer of and the quality of short-term investments that a hedge fund invests in. Future research can investigate the association of hedge fund manager failure with a liquidity position of the fund.

Practical implications

Investors must thoroughly the entirety of the fund including short-term securities.

Originality/value

Normally, it is the hedge funds that commit the fraud against investors. In this case, it is the multi-billion hedge funds run by sophisticated fund managers, who are the victims.

Details

Journal of Financial Crime, vol. 27 no. 1
Type: Research Article
ISSN: 1359-0790

Keywords

Article
Publication date: 1 March 1997

Majed R. Muhtaseb

The objective of this paper is to document the impact of several types of ESOP announcements on shareholder wealth. The market welcomes the news of initiation ESOPs…

Abstract

The objective of this paper is to document the impact of several types of ESOP announcements on shareholder wealth. The market welcomes the news of initiation ESOPs, nonleveraged ESOPs and ESOPs implemented by firms with B‐BAA Moody's bond rating. However, the market indifferently responds to announcements of expansion ESOPs, leveraged ESOPs and ESOPs adopted by firms with A‐AAA Moody's bond rating. Announcements of nonleveraged ESOPs, expansion ESOPs and B‐BAA rating ESOPs are found to be associated with some resolution of asymmetric information.

Details

Managerial Finance, vol. 23 no. 3
Type: Research Article
ISSN: 0307-4358

Article
Publication date: 12 June 2009

Majed R. Muhtaseb

The objective of this research is to educate investors and hedge fund industry stakeholders about a hedge fund manager's alarming activities prior to recognition of the…

371

Abstract

Purpose

The objective of this research is to educate investors and hedge fund industry stakeholders about a hedge fund manager's alarming activities prior to recognition of the fraud by the authorities. The lessons serve as red flags to stakeholders in the hedge fund industry such as prime brokers, auditors, administrators, accountants, custodians and government regulators, and especially investors conducting due diligence on hedge funds. A far‐reaching proposal is for the industry to found a hedge fund information depository (HFID) where participants/stakeholders provide information on any hedge fund on a regular basis. Such an information clearing‐house would facilitate a long overdue timely communication among hedge fund industry constituents. The services would be available for a fee. This service elevates transparency in the hedge fund community to an unprecedented level and could ultimately mitigate a manager's fraud.

Design/methodology/approach

A major hedge fund fraud case, Lancer Management Group, is used an example and application of HFID.

Findings

Investors in the Lancer funds lost more than $500 million. In the case of Lancer, there were several “alerts” or “triggers” many months before the actual filing of the SEC complaint against the fund. Hedge fund manager fraud could be mitigated through the establishment of the information depository. Had the depository been in place, some Lancer funds stakeholders could have made different decisions.

Research limitations/implications

Some hedge fund industry stakeholders may reluctantly join HFID. Researching the willingness of hedge fund industry stakeholders to join HFID would be a good extension of the current research.

Practical implications

Had a third party become aware of the alerts, this third party could have made a different investment decision. Most importantly, this depository would allow all the hedge fund industry stakeholders (accountants, administrators, auditors, marketers, prime brokers, custodians) to contemporaneously communicate with one another.

Originality/value

The approach and the solution are both unique. In addition, the topic is very controversial and timely, yet few business professionals explore research projects on fund manger fraud. HFID would be of great value to hedge fund industry stakeholders, especially investors.

Details

Journal of Investment Compliance, vol. 10 no. 2
Type: Research Article
ISSN: 1528-5812

Keywords

Article
Publication date: 9 May 2008

Majed R. Muhtaseb and Chun Chun “Sylvia” Yang

The purpose of this paper is two fold: educate investors about hedge fund managers' activities prior to the fraud recognition by the authorities and to help investors and…

1715

Abstract

Purpose

The purpose of this paper is two fold: educate investors about hedge fund managers' activities prior to the fraud recognition by the authorities and to help investors and other stakeholders in the hedge fund industry identify red flags before fraud is actually committed.

Design/methodology/approach

The paper investigates fraud committed by the Bayou Funds, Beacon Hill Asset Management, Lancer Management Group (LMG), Lipper & Company and Maricopa investment fund. The fraud activities took place during 2000 and 2005.

Findings

The five cases alone cost the hedge fund investors more than $1.5 billion. Investors may have had a good opportunity for avoiding the irrecoverable costs of the fraud had they carefully vetted the backgrounds of the hedge fund managers and/or continuously monitored the funds activities, especially during turbulent market environments.

Originality/value

This is the first research paper to identify and extensively investigate fraud committed by hedge funds. In spite of the size of the hedge fund industry and relatively substantial level and inevitably recurring fraud, academic journals are to yet address this issue. The paper is of great value to hedge funds and their individual and institutional investors, asset managers, financial advisers and regulators.

Details

Journal of Financial Crime, vol. 15 no. 2
Type: Research Article
ISSN: 1359-0790

Keywords

Article
Publication date: 16 March 2010

Majed R. Muhtaseb

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…

Abstract

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.

Details

Journal of Investment Compliance, vol. 11 no. 1
Type: Research Article
ISSN: 1528-5812

Keywords

Article
Publication date: 7 September 2015

Majed Muhtaseb

– To describe the fraudulent activity of investment manager Kirk S. Wright and to discuss its implications for investors and professional associations.

110

Abstract

Purpose

To describe the fraudulent activity of investment manager Kirk S. Wright and to discuss its implications for investors and professional associations.

Design/methodology/approach

Describes how Mr Wright established and built his fund business, how he solicited investors, how he falsified financial reporting to investors, how investors discovered his fraud and filed lawsuits, how the US Securities and Exchange Commission (SEC) and the Federal Bureau of Investigation (FBI) took disciplinary action, and how National Football League (NFL) players unsuccessfully sued the NFL and its players’ union for recommending Mr Wright’s firm. Draws lessons from the story for investors and associations.

Findings

Since hedge funds are not as strictly regulated as other investment vehicles, investors need to take extra steps to not fall prey to unscrupulous fund managers.

Originality/value

Detailed, informative case study.

Details

Journal of Investment Compliance, vol. 16 no. 3
Type: Research Article
ISSN: 1528-5812

Keywords

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