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[ThatHawaiiGuy]

[Hedge funds:] SHOW US THE MONEY

By CHRISTOPHER BYRON


Michael Lauer
Lancer chief
- Bloomberg News




August 4, 2003 -- LAST week brought some familiar news from the anything- goes world of hedge funds: Yet another hedge fund suddenly found itself in hot water.

This time the fund in question - a $700 million Norwalk, Conn., outfit named Durus Capital Management - 'fessed up to a series of "inadvertent" stock trades that look plainly to have been designed to corner the market in two obscure biotech companies in the Durus portfolio and force their stock prices into orbit.

The news regarding the trading activities of the hitherto unknown Durus fund simply echoes some similar portfolio-pumping antics by the larger, and older, Lancer Group of hedge funds - about which we've written plenty already.

Lancer operated out of offices on Park Avenue and in Stamford, Conn., until the Securities and Exchange Commission shut them down last month - and for activity that looks a lot like what Durus Capital seems to have engaged in.

So far as the investing public knew, the two funds could not have been less alike.

Lancer had been in existence for nearly a decade, and had been widely praised in the press for its superior performance year after year in the bull market of the 1990s. By contrast, Durus had been in existence for less than two years and was almost unheard of, even within Connecticut's gossipy hedge fund community.

At its zenith last winter, Lancer boasted having more than $1 billion of assets under management, while Durus was thought to be managing barely a third that much money. Lancer was believed to be heavily invested in defense and aerospace stocks. Durus was thought to be a biotech investor.

Yet for all those differences, the two funds did in fact have one thing in common, and in the end that is all that now really matters: Almost nothing the public thought it knew about either one has turned out to be true.

So the point seems pretty obvious: How many more instances of this sort of thing are going to be needed before Washington wakes up and brings the out-of-control and almost totally unregulated hedge fund industry to heel?

As we've been warning in this space for quite a while now, hedge funds are a ticking time bomb in the heart of capitalism. You don't know where their money comes from, or what's in their portfolios, or almost anything else an informed investor needs to know before handing over money.

Yet the very lack of regulatory oversight has allowed this industry to grow in the dark, like mushrooms on a mountain of rotting bull-market manure, until it now accounts for an estimated 20 percent of all the equity trading on Wall Street. This is simply intolerable and has to end.

REMEMBER the 1998 collapse of Long- Term Capital Management? That was the first of the big egg-on-our-face hedge fund surprises. In the dark, and while no one was paying the slightest attention to what it was doing, this fund leveraged its $5 billion of investors' cash into $125 billion of borrowed money, then poured the whole wad of it into securities ranging from Danish mortgage obligations to U.S. junk bonds.

Then the fund collapsed, threatening a global financial panic that the Federal Reserve averted by printing so much money, and so fast, that the stock market swelled within a matter of months into the biggest bubble Wall Street has ever known.

The Long-Term Capital debacle was followed almost immediately by the meltdown of a second multibillion-dollar fund, Ellington Partners, which also caught the entire world by surprise. And after that have come yet more - a seemingly endless stream of funds no one had previously ever heard of, erupting suddenly in hundreds of millions of dollars in losses, then shutting down to the predictable harrumphing of the SEC and the rolling drumbeat of investor lawsuits.

The names of the funds - Beacon Hill Asset Management, Cambridge Partners, Gotham Partners, Manhattan Investment, Lancer and now perhaps Durus - were barely known even on Wall Street until they got into trouble. And each time a new name has surfaced, it's been accompanied by the chorus of "one bad apple" from the rest of the industry.

But the reality is exactly the opposite: Most of this industry is rotten, and it is only the exceptional fund that can show its investors straight-up accounting and a portfolio of legitimate investments.

The situation that's been uncovered at the Lancer Group is appalling. The fund has turned out to consist almost entirely of worthless, penny-stock trash, much of it controlled by mob-connected felons and career-long Wall Street scofflaws.

Yet even though evidence of this was in the SEC's own files for years, neither the regulators nor federal law enforcement did a single thing until the story caught fire this spring in the press. Now investigators are running all over the country trying to catch up with a situation that never should have been permitted to develop in the first place.

Meanwhile, a kind of hedge fund lite version of Lancer has already developed in the Durus case. In it, the fund's founder and managing partner, a college dropout named Scott Sacane, filed papers with the SEC last week acknowledging that Durus had improperly but "inadvertently" bought up 76.7 percent of the outstanding common stock in an obscure, money-losing biotech stock called Aksys Ltd.

The filing said the purchases, which had taken place day after day for four entire months beginning in April, had somehow all been a big mistake - implying that Sacane had apparently fallen asleep on the "buy" button on his computer as the tightening market caused by his purchases lifted Aksys' price from $3.50 to nearly $16, pulling up Durus' own performance numbers along with it.

A big mistake? Well, scarcely had Sacane 'fessed up last week to the Aksys mistake than Durus filed papers with the SEC acknowledging a second set of Big Mistake purchases, involving yet another obscure, money-losing biotech stock in its portfolio: Esperion Therapeutics Inc.

Thanks to Durus' big mistakes, by the start of last week the combined market value of these two stocks topped $1 billion, with half of it sitting in the Durus portfolio. In other words, for a brief shining moment, the Durus fund appeared to have reached nearly $700 million of value, with an estimated 73 percent of it accounted for the purchases of two obscure stocks the fund didn't know it was buying.

Frankly, this is preposterous. Sacane looks to be either one of the stupidest investors in the history of Wall Street, or an out-and-out liar. Either way, it's no consolation to the everyday folks who had never even heard of Durus before waking up late last week to discover that their investments in Esperion and Aksys had collapsed by nearly 25 percent overnight on the news that a hedge fund had apparently manipulated their share prices into orbit illegally.

Hedge funds have been justified from Day 1 by the argument that because they are only open to rich investors, who are presumably able to tell good investments from suckers' bets, they don't need to be regulated and controlled.

But that's absurd. The absolute best that can be said about this industry, as the evidence now copiously shows, is that far too many hedge funds seem to be managed by some of the worst, most reckless, most irresponsible money managers Wall Street has ever known - and backed by some of the stupidest rich people on earth.

THERE is no justification whatsoever for this industry to be regulated any differently from the mutual fund industry, because that's all hedge funds actually are - unregulated mutual funds for the rich. Hedge funds need to be required to produce audited, public statements of their financials, and to file fully detailed and timely reports on their portfolio investments.

It should be illegal to invest in funds that do not do this. And that, I hope, is what the SEC will conclude when it releases its much-anticipated recommendations - probably soon after Labor Day - for defusing the hedge-fund time bomb.

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http://www.nypost.com/business/2272.htm