August 25, 2005
Connecticut Investigates Hedge Fund for Solvency
By GRETCHEN MORGENSON</p>
<p>State and federal officials in Connecticut are investigating the possible collapse of the Bayou Group, a hedge fund and brokerage firm in Stamford that managed an estimated $400 million for its investors, according to two people briefed on the investigation.</p>
<p>Clients of the Bayou Group apparently grew concerned about the firm’s status in recent days, when refund checks it had sent to customers could not be drawn upon for lack of funds, one of the two people briefed on the investigation said. In addition, telephones at Bayou went unanswered.</p>
<p>“We are aware that there is a situation with people not being able to be in contact with the company,” said James Heckman, a spokesman for the Connecticut Department of Banking. “We are looking into it. Beyond that, I can’t comment.”</p>
<p>Christine Sciarrino, an assistant United States attorney for Connecticut, who leads the financial litigation unit of that office’s civil division, declined to comment on the matter. A spokesman for the United States attorney’s office did not return a phone call seeking comment.</p>
<p>Regulatory filings indicate that the Bayou Group is overseen by Samuel Israel III, 46, of Harrison, N.Y. The Web site of the National Futures Association, a self-regulatory organization of the commodity futures industry, lists Mr. Israel as a member of one of its advisory committees.</p>
<p>A telephone call yesterday afternoon to the Stamford office of the Bayou Group was not answered. A message left at Mr. Israel’s home was not returned.</p>
<p>According to documents filed with the Securities and Exchange Commission, Bayou started four hedge funds in January 2003, expecting to raise more than $250 million from wealthy individuals. The minimum investment in each fund was $250,000. They were called Bayou Superfund, Bayou No Leverage Fund, Bayou Affiliates and Bayou Accredited Fund.</p>
<p>Hedge funds, which are lightly regulated investment funds aimed at wealthy investors, have grown significantly in recent years. Tremont Advisors, a firm that tracks hedge funds, said that individual hedge fund managers manage $1 trillion today, up from $120 billion in 1994.</p>
<p>While hedge funds produced stellar returns in the years immediately following the bursting of the Nasdaq stock bubble in 2000, more recently many of them have had difficulty outpacing returns in the overall stock market. Last year, the hedge fund index rose 9.6 percent, while the Standard & Poor’s 500-stock index increased 10.9 percent.</p>
<p>The explosion in assets under management at hedge funds has worried some market participants, because they are not subject to the intense regulatory scrutiny of other investment advisers.</p>
<p>In recent months, for example, federal investigators have been trying to unravel the apparent collapse of the KL Group, a hedge fund advisory business in West Palm Beach, Fla. Officials investigating that failure have said that $200 million may have been lost. Two of the firm’s principals, who have been sued by the S.E.C., have disappeared.</p>
<p>According to the people briefed on the investigation into the Bayou Group, its brokerage firm subsidiary, known as Bayou Securities, conducted trades for its hedge funds. The firm’s trades were cleared by Bear Stearns, one of the biggest firms in the business of providing administrative and financing services to hedge funds. A Bear Stearns spokeswoman did not return a phone call seeking comment.</p>
<p>Bayou has had regulatory troubles before. In 2003, Connecticut’s banking department filed an administrative proceeding against Bayou Securities, which was started in January 1996, contending that the company’s records did not fully reflect the business that it was conducting. Bayou settled the proceeding, without admitting or denying wrongdoing, but paid a $7,500 fine and agreed to provide banking regulators with all complaints lodged against it by Connecticut residents until October 2005.</p>
<p>As part of its settlement, Bayou said that it had reviewed and adopted “supervisory and compliance procedures designed to improve regulatory compliance,” and that the procedures would ensure that the firm’s records would be accurate.</p>
<p>Also in 2003, Mr. Israel and a colleague, Daniel Marino, were sued by Paul T. Westervelt Jr., and his son, Paul T. Westervelt III, in a breach of contract case in Federal District Court in the Eastern District of Louisiana. The plaintiffs in the case contended that Bayou’s management persuaded them to join the firm but failed to provide them with the necessary business documents and financial information relating to the firm. According to the complaint, after the elder Mr. Westervelt joined Bayou, he discovered what he considered to be “possible violations of S.E.C. regulations governing the operating of hedge funds,” and other possible violations.</p>
<p>The case was dismissed from federal court in November 2003 after the judge overseeing it ordered it to be heard by an arbitration panel, under NASD rules. It is not clear whether an arbitration was started. Lawyers representing both the plaintiffs and Bayou did not return phone calls seeking comment last night.