Bayou hedge fund fraud continues to reverberate

Date: Tuesday, July 22, 2008
Author: HedgeWeek

Frustrated investors in the defunct Bayou Management hedge funds run by Sam Israel, the fund manager who faked his death last month in a vain bid to escape prison for a USD450m fraud, are now going after the world's biggest investment bank, Goldman Sachs.

A legal claim seeks USD20m from Goldman, which acted as prime broker to the Bayou funds, clearing trades, taking custody of their securities and providing reports on the hedge funds' investments.

The lawsuit, which was filed as a private arbitration case in US federal court, claims that Goldman Sachs Execution and Clearing provided monthly statements to Bayou highlighting losses of more than USD88m between August 1999 and August 2005. It alleges that Goldman knew that Bayou was reporting significant gains to investors but did nothing about it.

'Through either gross negligence or a wilful choice to ignore the signs of fraud, GSEC failed to diligently investigate the red flags it was made aware of it, to contact Bayou's auditors to request additional information, or to alert the appropriate authorities of what it had learned,' the statement says.

The lawsuit underlines the fragility of the relationship between prime brokers and the hedge funds they service. Many regulators have decided they can keep track of the risks run hedge funds by supervising the activities of their prime brokers, because the latter provide the finance that allows hedge funds to gear up their bets. This assumption may be due for a rethink.

The fact that the lawsuit seeks only USD20m from Goldman seems bizarre considering the circumstances and the scale of legal fees involved. Perhaps the creditors are calculating that with such a relatively small sum at stake, Goldman is more likely to settle the lawsuit without going to trial. In troubled times, anything goes - even a quick USD 20 million.