Authorities Probe a Top Hedge Fund

Date: Monday, November 15, 2010
Author: Jenny Strasburg, The Wall Street Journal

SEC, U.S. Investigate Whether Harbinger Capital Gave Preferential Treatment to Some Clients

One of America's most prominent hedge funds is being probed by federal authorities, who are investigating whether the firm gave illegally preferential treatment to its founder and to some clients.

The Securities and Exchange Commission and U.S. Attorney's office in Manhattan are looking into whether Harbinger Capital Partners misled investors by failing to disclose in a timely fashion a $113 million personal loan it extended to founder Philip Falcone from the firm's funds, according to people familiar with the matter.

The authorities also are examining whether Harbinger improperly allowed some clients to withdraw money following the financial crisis while barring others from doing so, these people said.

In an interview, Mr. Falcone said Harbinger "did not give preferential treatment to any investor."

Reuters

Hedge fund manager Philip Falcone.

He said the personal loan was made in accordance with the terms of the fund and disclosed in the firm's audited financial statements for 2009. He said it "was reviewed by our accountants and outside legal counsel." Mr. Falcone said he has paid back more than $70 million of the loan, with the balance due in 2014. Also, he said the loan has been profitable for investors, and was backed by his holdings in the fund.

Mr. Falcone declined to comment on whether he or the firm has been contacted by investigators. It is unclear whether the inquiries will lead to any legal action.

The parallel criminal and civil probes come as regulators are conducting a broad examination of hedge funds. Authorities are looking at trading by the private funds, which cater to sophisticated investors such as wealthy individuals, public pension funds and endowments. Also under scrutiny is the clout the funds have in markets and the methods they use to value their asset prices, which influence the fees they earn from clients.

The investigation is a potential black eye for Harbinger, known in the industry for both its size and its role in pushing for corporate changes at companies where it holds a significant ownership stake, including New York Times Co.

In 2007, Harbinger scored gains betting against bonds backed by subprime mortgages. Investors flocked to the firm, helping it rise to $26 billion in assets in 2008 before it shrank from losses and client withdrawals. The firm now manages about $9 billion.

Harbinger's main fund has declined about 15% this year, a person familiar with the matter says, as the average hedge fund has seen positive returns. Some clients, including Goldman Sachs Group Inc. and Blackstone Group, have recently put in withdrawal requests, according to people familiar with the matter.

Mr. Falcone, a former Barclays trader, grew up in Minnesota and played hockey at Harvard University.

In 2008, like many hedge funds, Harbinger stumbled as its investments in energy, finance and other companies lost value and some investors sought to withdraw money. In 2009, as Harbinger's biggest funds rebounded, Mr. Falcone opened new funds and delved more deeply into deals in the telecommunications industry.

One focus of the investigation is the loan Harbinger executives authorized in late 2009 to help Mr. Falcone pay personal taxes, people familiar with the matter say. Mr. Falcone borrowed the funds from a Harbinger fund that had $2.5 billion in assets, while clients were barred from withdrawing money from the fund at the same time, according to fund documents and people familiar with the matter.

The SEC received investor complaints after Harbinger disclosed the loan in fund documents in March, according to people familiar with the matter. The agency's enforcement unit began an inquiry into the loan this summer, said one person. A concern is that investors weren't informed at the time Mr. Falcone borrowed the funds, the people say. Another issue is that the loan might have increased the risk of losses without clients' knowledge. The loan was reported in September by Bloomberg News.

Also at issue is whether clients were equally well-informed, including about risks to the funds, during the restructuring of Harbinger funds, according to people familiar with the matter.

One issue is whether some clients got different withdrawal terms than others, they say. It is unclear which clients are the focus of concern.

Last year, Harbinger executives were working to convince clients to keep their money in the firm's biggest funds. The discussions came after Harbinger suspended redemptions in the funds in December 2008 and set aside hard-to-sell holdings, according to investors.

In 2009, the firm also tightened rules about investor withdrawals, adopting a 25% limit per quarterly period for each investor as opposed to a limit that applied to all clients combined, according to investors and fund documents reviewed by The Wall Street Journal. The move, which was put to a client vote, meant any investor wanting to redeem fully could opt to do so over a year, with the set-aside illiquid assets potentially taking longer to sell.

Hedge-fund managers have wide leeway to change terms and withhold client money, which in some cases can protect assets during crises. The issue of equal treatment of investors is a focus of the SEC's enforcement unit, which has investigated funds to determine whether some clients are favored with better information or financial terms to the detriment of others.

Philip Falcone

Mr. Falcone has been pushing an ambitious plan to launch a global wireless-satellite network, and has dedicated the majority of his assets in his biggest hedge fund to the venture, called LightSquared.

In the process, Harbinger has come to look less like the hedge-fund firm it was when many investors came to it, and more like a private-equity firm making a concentrated, long-term bet. Investors say the strategy shift has contributed to anxiety over having assets locked up in the firm.

Mr. Falcone has some $2 billion of his own money invested in Harbinger, investors say, citing that as a strong reason to support his strategy.

In 2009, while some investors were asking for withdrawals, others were lining up to put money into Harbinger. They included Soros Fund Management, which during the past year became a significant new investor, say people familiar with the matter. A Soros spokesman declined to comment.

Write to Jenny Strasburg at jenny.strasburg@wsj.com