Trust, but Verify
• We know the importance of being diligent, but there usually no clear guidance as to how to be diligent.
• Even the professional lie-detectors – lawyers – can do no better than “just look for something unusual.”
• However, detecting something as “unusual” requires experience, which is more often than not subjective and not easily transportable.
• Therefore, these case studies are my attempt at systematizing my experience based on the following principles.
• As President Reagan said: Trust, but Verify.
Profile
• Sam Israel started Stamford, CT-based Bayou Management, LLC in 1997
• Short-term Equity Trading
• Managed $450 million at peak and lost $350 million of investors’ capital
Fake Performance
Source: SEC v. Bayou Management LLC, et al, Markov Process International, LLC
Sam Israel claimed Bayou’s short-term trading
strategy enabled him to generate his stable returns
Fake Auditor
• Bayou told potential investors that Grant Thornton was its auditor
• But, in reality, it was Richmond-Fairfield Associates, CPA, PLLC which was established by Dan Marino, CFO
• Located at a tiny office at 575 Madison Avenue
575 Madison Ave. Suite 1006
How come an audit firm for a $400 million hedge
fund uses this tiny rental office space?
Marino’s Name
Richmond-Fairfield was
registered under Bayou
CFO’s name…? Why??
Source: New York State Education Department, Office of the Professions
Fraud Administrator
• Initial administrator Admiral resigned since Bayou refused to provide data
• Bayou then purportedly appointed Global Standard Financial Group Ltd.
Resignation Letter
On November 9, 2004, Admiral Administration
resigned and gave this “unusual” explanation…
Source: Report of the Joint Provisional Liquidators of Bayou Offshore Master Fund; Bayou Offshore Fund A,
Ltd; Bayou Offshore Fund B, Ltd; And Bayou Offshore Fund C, Ltd, 15 December 2005
Fake Administrator
Bayou Offshore Funds appointed an
administrator unrecognized by the
Cayman Islands Monetary Authority
on April 1, 2005;
This means that Bayou operated
without an administrator for three
months…?
Source: Report of the Joint Provisional Liquidators of Bayou Offshore Master Fund; Bayou Offshore Fund A,
Ltd; Bayou Offshore Fund B, Ltd; And Bayou Offshore Fund C, Ltd, 15 December 2005
Recommendations
• Read the Fine Prints of the Financial Statements
• Check the Legitimacy and the Independence of the Audit Firm
• Check the Legitimacy and the Independence of the Administrator
To read the case study: http://www.being-diligent.com/case-n-1-bayou/ The Bayou Story: http://www.being-diligent.com/trust-but-verify/the-bayou-story/
Summary
• There are many similarities among hedge fund fraud cases (very stable and too good track records, promissory notes, fake service providers, etc.)
• No matter how clever they are, fraudsters are still human beings and prone to leave traces of their misconducts
• However, you really need to be diligent to find those traces and make informed judgment
For More Information
The Importance of Being Diligent is a blog of hedge fund case studies managed by Sus Volans. Please visit our website and sign up for an e-mail subscription.
http://www.being-diligent.com