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How to Run Your Hedge Fund From a Prison Cell

Date: Friday, October 5, 2012
Author: Jonathan Weil, Bloomberg

As if Americaís hedge-fund elite didnít have enough crises to worry about -- riots in Spain, the fiscal cliff, Lindsay Lohanís hotel brawl -- the parade of underlings copping pleas to insider-trading crimes just keeps growing. Every week it seems another one flips, promising to turn stateís evidence.

Time is money, as they say. And it would take a true genius to make money out of the kind of time some of these people are facing. Still, you donít get to work at a $14 billion hedge fund like SAC Capital Advisors without abundant self-confidence and inner drive. So if you are someone like Jon Horvath, now isnít the time to give up on your dreams, just because you face the prospect of years in the slammer.

Horvath, 42, is the former SAC analyst who pleaded guilty last week to securities-fraud charges after admitting to participating in an insider-trading ring. Soon he will probably join former Galleon Group kingpin Raj Rajaratnam and dozens of other recently convicted hedge-fund masters and tipsters now populating Americaís minimum-security prisons.

We can imagine what the fittest among them might be thinking: ďNow that Iím truly on the inside, how can I use this opportunity to make as much money as I did on the outside?Ē Perhaps the greatest profits could go to those with the longest sentences. Call this the ultimate lockup agreement.

Criminal Minds

All it takes is some imagination. Suppose you are a skilled hedge-fund veteran who has just reported to prison. A little- appreciated fact is that there is no U.S. law preventing a convicted felon from managing a hedge fund, as long as that person isnít required to be registered under the Investment Advisers Act. Or at least that is what the attorney who lost your case at trial once told you.

Fortunately, it is understood that there are two kinds of crooks in this business: those who get rich by cheating their clients, and those who make their clients richer by cheating everyone else. You are the latter kind. Your clientsí faith in you remains unshaken. You traded on inside information -- for them! You risked going to prison -- for them! You were doing Godís work -- for them!

They stood to make money even if you got caught. And sure enough, you did. Your clientsí interests always come first. (And unlike Goldman Sachs you really mean it.) Now they owe you. Judging by all those kind letters they wrote begging the judge in your case for leniency, they know it.

You pull out the rock you smuggled in to mark the passing days on your cellís walls, and proceed to carve out a plan, which goes something like this: In these troubled economic times, when the stock market is soaring yet the only thing keeping the financial system alive are empty speeches from an Italian central banker, investors need the safety and security that can only come with having no ability to access their money for anything.

Thatís right, you will tell them: They should park their money with you -- someone they can trust who, due to extenuating circumstances, wonít be able to touch it, either.

You figure the standard hedge-fund-industry fees shall apply: 2 percent of assets and 20 percent of annual returns, to protect your clients from doing anything with their money themselves, like losing it on shares of Facebook. Except there will be no profits to speak of at your new fund, Long Sentence Capital Management.

Black Box

All money will be placed in ordinary deposit accounts at a Cayman Islands branch of a U.S. too-big-to-fail financial institution such as JPMorgan Chase. (For clients who want to feel like you are doing actual work, tell them: ďThe algorithms will take care of the rest.Ē) A brilliant strategy, you tell yourself. When the rest of the world is down 90 percent, your clients will still be rich. Who needs Nassim Nicholas Taleb and his black swans when they have you and your black box?

Now for the hard part: What to do with the rest of your time? Sure, you could spend years feeling sorry for yourself, when you arenít busy selling your insider knowledge of the prison industry to an expert-network service. But think about poor Jon Horvath. He passed along insider tips from an employee at Dell Inc. (DELL) The government called this a crime.

Imagine that. Dell and its founder, Michael Dell, committed accounting fraud, if we are to believe what the Securities and Exchange Commission claimed in a 2010 civil lawsuit. Only a fool would trade Dell without inside information. Otherwise the risk of loss is too great because, as the SEC made crystal clear, you canít believe anything the company says. Yet Horvath is going to jail. And the SEC let Michael Dell stay as Dellís chief executive officer! He didnít even admit anything under the settlement. Who does the SEC think this guy is? Steve Jobs?

There is nothing you can do for Horvath. You have urgent matters to consider and no time to waste.

A guard knocks on your door. He has a message from the associate warden. Good news: Your request for e-mail privileges has been granted.

Tomorrow will be the start of a new, glorious future.

(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)

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Todayís highlights: the editors on Venezuelaís high-stakes election and on the fallacy of small business as job creator; Stephen L. Carter on why itís OK to skip the presidential debates; William Pesek on quantitative easing in the U.S. and Japan; Brian T. Haggerty on the perils of military intervention in Syria; Paul Hodgson on recouping bonuses from bank executives.

To contact the writer of this article: Jonathan Weil in New York at jweil6@bloomberg.net