Fraud within hedge funds on the rise

Guy Locke, Head of the
Insolvency and Recovery

Monday,  February 13, 2006

Along with the phenomenal growth of hedge funds, there has also been a steady rise in funds collapsing as well.

The Head of the Insolvency and Recovery at local legal firm Walkers, Guy Locke, said that there has been an expectation of big shake out in the hedge funds sectors and there has been a definite rise in troubled funds in the last six months. 

“The nature of the business means we have complicated portfolios,” said Mr Locke.

“We have found that what tends to happen in a number of cases is that a fund starts to lose money and some investment managers try to cover up the losses by inflating values in the portfolio, which perpetuates itself until it gets to the stage where it can’t continue anymore and the funds collapse.”

For example he said that an investment manager assigns an incorrect net asset value where people are subscribing and redeeming their shareholdings. So an investor will buy a share that is said to be worth a dollar but it is actually worth 30 cents, then the share is redeemed for a dollar and ultimately it creates more problems for the remaining investors that are still holding onto their shares. 

Mr Locke has been working on three high profile funds that underwent similar situations of fraudulent valuations: Beacon Hill, Philadelphia Alternative Management and Bayou Funds. 

The Bayou Fund base collapsed in August 2005 and it involved over $300 million of investors’ money including institutional investors, such as pensions, as well as individuals and there was also reported theft in addition to the fraudulent valuations. 

Another part of the problem concerning hedge funds, which can contribute to their downfall, is the complicated financial instruments that are used. 

The combination of complex instruments and investment managers misrepresenting the net asset value can create what Mr Locke described as a mess. 

He said that with 80 percent of the world’s hedge funds domiciled in the Cayman Islands it only takes a small percentage of failures for there to be an appearance of a growth in collapses of the funds. 

“This is just a symptom of the kind of business we do. There are so many hedge funds that are successful, it only takes a small number of funds to impact the growth of the business,” he said. 

Another high profile collapse involves the three companies related to Parmalat, the large Italian dairy firm and food company, which has been described as the largest bankruptcy in the history of Europe. It has been suggested by financial experts that the firm became the tool of the banks which had invented, built up, and managed the speculative scheme that eventually brought down the firm.

The liquidators for the companies are suing banks and accounting firms for approximately $1 billion. 

According to Mr Locke the case is still in the early stage with a number of hearings scheduled in the United States. 

shurna@caymannetnews.com

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