- $60 million "unaccounted for"!
- $101 million turned over to a gang of Arizona con artists who said they'd make up the shortfall for the fund manager!
- Fund manager's attorneys have withdrawn from the case due to unspecified ethical considerations. Read: Oh shit we can't defend this guy, oh shit he's so fucking dirty, oh shit shit shit!
- Sham accounting firm! Sham accounting firm! Sham accounting firm!
- $3.5 million in Spongebob Squarepants checks!
- CFO writes suicide note, is checked into mental hospital!
Did Bayou Bet With Con Artists?
Arizona Says Manager Gave $101 Million to Shady Group, Desperate to Recoup Losses
By IAN MCDONALD and JOHN R. EMSHWILLER
Staff Reporters of THE WALL STREET JOURNAL
September 2, 2005; Page C1
Arizona state authorities said the hedge-fund manager under investigation for what federal prosecutors now allege was a massive fraud turned over $101 million of his clients' money to a group of suspected con artists, in a long-shot bet to mask hundreds of millions of dollars in missing assets.
In the first official allegation that Bayou Management LLC was rife with fraud, the Justice Department's U.S. Attorney office in Manhattan yesterday alleged in a civil lawsuit that Bayou had overstated its assets and returns since 1998, a year after it started investing.
Arizona authorities seized the $101 million in May after becoming suspicious of a man to whom Bayou chief executive Samuel Israel III had turned over the money. The authorities said Mr. Israel either was duped into a fraud that promised to turn the money into $7.1 billion within 10 years, or participated in the scheme to cover up the apparent collapse of his hedge funds, based in Stamford, Conn.
Arizona Attorney General Terry Goddard2 and WSJ's Ianthe Jeanne Dugan discuss the probe, and WSJ Reporter Ian McDonald comments separately3 on the story. Plus, Connecticut Attorney General Richard Blumenthal4 joins the discussion, stressing the need for reform.
The details were disclosed in a hearing in Phoenix in which Mr. Israel's attorneys were permitted to withdraw from the case based on unspecified "ethical considerations." The hearing was one of several developments in the Bayou saga, which came under investigation by state and federal authorities after Mr. Israel unexpectedly announced plans to shut down the funds in July and stopped communicating with his investors.
Bayou told investors it was managing more than $400 million last year, but bank records suggest it may have had only $160 million, and that at least $60 million of that is unaccounted for.
"All of the assets of Bayou ... constitute proceeds of criminal activity," federal prosecutors said in their suit. "Bayou perpetrated a fraud on its investors." The lawsuit demands that all Bayou's funds, including those held by Arizona, be turned over to the federal government so they can be returned to the firm's investors.
The prosecutor said that at the end of 2003 the Bayou Superfund -- one of its four hedge funds -- reported $192 million in assets, including $27 million in trading gains. In reality, the fund had less than $54 million in assets and trading losses of $35 million, the prosecutor said. The suit alleges Bayou said its books were subject to independent audits by what turned out to be a "sham" accounting firm, Richmond-Fairfield Associates. The firm's registration papers were filed in New York State by Bayou chief financial officer Daniel Marino in October 2000. It "conducted no audits, independent or otherwise." Prosecutors said investors put more than $300 million in Bayou funds over the years. The lawsuit doesn't say how much money is left.
Earlier, a New York state judge approved motions to freeze both Mr. Israel's and Bayou's accounts at the request of one of its investors and a man who had loaned Mr. Israel $3 million. "Am I to believe that sophisticated investors gave this person $400 million to invest?" New York state justice, Charles E. Ramos, asked during a hearing. "You know who P.T. Barnum was? He was right. This is amazing."
Arizona authorities and federal prosecutors described what they believe was a complex but time-worn attempted fraud known as "prime bank instrument fraud." The scheme involves promising investors stunning profits from high-yielding bank debt. But then the money disappears in a dizzying number of rapid-fire moves from bank to bank around the world.
"Alchemy has nothing on this," said Arizona Assistant Attorney General Cameron Holmes in an interview.
Arizona prosecutors speculated in court that Mr. Israel may have teamed up with the deal's alleged architects -- two investors, Lewis Malouf and Tedd Collins and New Jersey money manager Karl Johnson -- to have an excuse for empty coffers later.
"Whether this was an act of desperation in an attempt to recover previously misinvested funds, or was an attempt to create an apparent loss ... with a side agreement with Malouf to split the $100 million at a later time, is a question that will await further investigation," Arizona authorities in a court filing said yesterday.
Mr. Malouf, whom Arizona authorities say was a former Bayou employee in Burbank Calif., and Mr. Johnson, who authorities say runs Majestic Capital Management out of his home in Flemington, N.J., declined to comment. Neither Mr. Israel nor Mr. Collins could be reached at what are believed to be their home telephone numbers.
Neither Bayou nor Mr. Israel appear to have legal representation. At a separate hearing in New York, where a state judge approved the freezing of Bayou's and Mr. Israel's accounts, neither Mr. Israel nor an attorney representing him showed up.
Calls to two New York attorneys who recently represented Mr. Israel and the firm weren't returned. Arizona's Mr. Holmes said he expects soon to turn over evidence he has gathered to federal authorities and leave the matter to them.
Investigators are struggling to untangle labyrinthine shifts for the money that was seized by Arizona authorities. Between July 8 and Oct. 5, Bayou wired $120 million from the Bayou funds' Citibank accounts to two accounts at German banks. In early December, $121 million was wired from the German banks to a London securities account in Mr. Israel's name alone, records show.
At the end of March this year, Messrs. Israel and Malouf signed a deal under which a $100 million investment would grow to $7.1 billion a decade later. That "appears to be the root of the downfall for Bayou," Arizona authorities said.
After Mr. Johnson tried to open $100 million accounts at a battery of institutions with different stories about the money's origin, Arizona Attorney General Terry Goddard seized the money.
Additional evidence of Mr. Israel's apparently increasingly desperate straits emerged in another lawsuit that was also the subject of the hearing before Justice Ramos in New York. On June 14, Mr. Israel borrowed $3 million from Steven Starker, an executive with Bass Trading in New York, Mr. Starker says in his suit against Mr. Israel. Mr. Israel said he needed the money to settle protracted divorce proceedings and that repayment wouldn't be an issue since he was worth $18 million, according to a letter Mr. Israel wrote5.
He asked Mr. Starker for an extension to mid-August when he didn't repay his debt as planned in mid-July. In the following weeks, Mr. Israel repeatedly promised to pay Mr. Starker and missed other deadlines, according the suit and emails from Mr. Israel to Mr. Starker included in court files.
Mr. Israel assured Mr. Starker that he had millions of dollars hidden from his wife in overseas accounts and that he'd be flush with cash after the Arizona authorities released the $101 million. In a letter he also promised to partly repay his debt by directing trades through Mr. Starker's firm.
But Arizona officials rebuffed Mr. Israel's and Bayou's claim on the money, pointing their inability to concrete proof that the money belonged to them.
In July, Mr. Israel told Mr. Starker in an email he "would never screw him nor anyone else," according to court papers. Mr. Israel told Mr. Starker that Wachovia would soon lend him $5 million, but the money never showed up according to court papers.
Checks for $3.15 million from Mr. Israel to Mr. Starker -- bearing characters from the cartoon Sponge Bob Square Pants -- bounced, court records show. Mr. Israel's wife told Mr. Starker's counsel that she hadn't received any money from her estranged husband, according to court papers.
Scrutiny of Bayou heated up on Aug. 16 when an already-rattled Bayou investor discovered what police have said was a suicide note and fraud confession on Bayou's Mr. Marino's desk. Police located Mr. Marino, unharmed, and brought him to a local hospital, where he was evaluated and released.
Mr. Starker says in court papers that Mr. Israel, in making excuses for being unable to repay him, claimed that Mr. Marino had killed himself.