Thursday, July 10. 2008
Catherine Wilson, Bureau Chief
Hedging Your Bets In Investments
On June 10, 2008, a 2006 GMC Envoy belonging to hedge fund manager, Samuel Israel, was found abandoned on the Bear Mountain Bridge
with the words “Suicide is Painless” (the theme song from the M*A*S*H television series) finger-etched in dust on the hood. Israel was due to start a twenty-year prison sentence for his involvement in a $450 million fraud. Local police and Federal investigators believed that Israel faked his own death to avoid prison. Along with questions as to where Israel was; until he emerged surrendering to police in Massachusetts 23 days later, were additional questions as to how his investors, many of them local residents, could be duped by Israel and his fund, Bayou Hedge Fund Group, LLC of Stamford, Connecticut.
In the complaint lodged by the Securities and Exchange Commission (SEC) against Bayou, the allegations noted that “Defendants Samuel Israel III, Daniel E. Marino, and an associate, carried out a scheme to defraud investors in a family of hedge funds controlled by them directly and through defendant Bayou Management, LLC. From 1996 through 2005, Israel and Marino misappropriated, dissipated and lost tens of millions of dollars of their clients’ money that was invested in the Bayou Fund, and its successors, Bayou Accredited Fund, LLC, the
Bayou Affiliates Fund, LLC, the Bayou No Leverage Fund, LLC, and the Bayou Superfund, LLC (the “Funds”), and several related off shore funds organized in the Cayman Islands.
Investors deposited more than $450 million into the Funds over the course of their existence. To hide and perpetuate their fraudulent scheme,
the defendants knowingly misrepresented the value and performance of the Bayou Fund and the four successor Funds to clients; issued false and misleading financial statements, account statements and performance summary documents; fabricated “independent” audit reports from a fictitious accounting firm; and misled investors regarding other material facts”.
The definition of a hedge fund is a “private, largely unregulated pool of capital whose managers can buy or sell any assets, bet on falling as well as rising assets and participate substantially in profits from money invested. Hedge funds seek to offset potential losses by hedging
their investments using a variety of methods. Being outside the regulatory regime that applies to mutual funds greatly reduces the information a hedge fund is legally required to make public” (source: Wikipedia). Hedge funds can control billions of dollars and their investment trading can impact global markets.
More than half of all hedge funds are registered off shore, the most popular location being the Cayman Islands, a tax haven known for its loose regulations. Since hedge funds are sold via private placement, they are not advertised or offered to the general public. Hedge funds are
not for the average middle class investor; they require a minimum net worth, usually $1,000,000 to $5,000,000. So how did high-income,
and supposedly highly-educated, individuals get duped by Israel and his fund?
The same way ordinary investors do – they didn’t do their homework. The Guardian spoke with several local financial planners about the pitfalls all investors, both wealthy and average-income, fall into with their own investments.
C.J. Arditi, of Edward Jones Investments in Yorktown Heights, spoke to The Guardian at length about what local residents should look for when seeking a financial planner/investment manager. “Cases like Sam Israel have the potential to ruin it for legitimate planners,” Mr. Arditi acknowledged. “People get skeptical. But there are simple steps they can take to make sure that a similar situation will
not happen to them”.
Chief among these steps is to investigate a planner’s background. Arditi advised that potential clients should look for “the plaques on the
wall” like Series 7 licenses, a nationally-issued license for securities representatives (i.e. stockbroker).
Arditi also advises “trusting your instincts. A client ultimately has to follow their gut. They should always meet the (financial) planner in their office, face to face, to discuss their goals, lifestyle, investment types, and fees. The more transparent the planner is with his/her fee structure, the better the relationship between planner and client will be. The more hidden the fee is, the more it will probably cost the client.
Planners should take the time to explain the different fees and fee structures for every investment considered and what the planner will do for the client to earn those fees. Also, the planner should explain what the industry norm is and how his/her fees compare”. Israel’s clients made the mistake of not investigating the fee structure of the fund – when the Bayou fund started to lose money on bad investments, Israel sought to attract new money into the fund by reducing his management fee and lowering the initial investment threshold to $250,000, a combination that attracted many middle-class investors seeking to “play with the big boys”.
But such “bargain-basement” fees and lowering of investment levels would have set off warning signals to more experienced investors, some of whom withdrew from the hedge fund at that point. Arditi stressed that clients should steer clear of investments that are ‘too good to be true’ and ‘get-rich-quick’ schemes. He emphasized, “There’s no such thing. The best investment strategies are the old stand-bys – buying
stocks for the long-term and sticking to systematic funding of those investments which will eventually even out the ups and downs of the markets over time”.
Arditi also advises working with a planner who is easily accessible. “Many large brokerage houses outsource their client calls to a call center
in Ohio or Mumbai,” Arditi noted. He went on, “A client has to identify themselves by number. With a personal planner, that planner knows
you, your lifestyle, and your family. The relationship is personal, not ‘cookie-cutter’. A personal planner gets to know all the stuff about you that matters so they can plan for your unique and specific needs”.
In contrast, many of Israel’s clients noted that they heard from him regularly while the funds were doing well, but once the funds started
to lose money, his communications ended. Arditi noted that clients should receive communications from their personal planners on a regular,
scheduled basis. “Clients should receive statements at least quarterly,” he said, citing his own operations, he continued, “My office will generate a statement for our clients for any activity each month, even if that activity is only dividends being issued. Plus, whenever there’s a trade on an account, a confirmation of that trade is issued to the client that day.” Trades on an investment account (i.e. the buying and selling of investments) raise other issues for investors.
“I do not have discretion in any account,” Arditi said. “I cannot make any trades without a client’s okay. However, there are individuals who may prefer automatic trades and may allow their planners to make trades on their behalf. Those clients should have online access to their accounts and even set up alerts to the computers or cell phones to notify them whenever there’s any activity on their investments”.
Arditi stressed the importance of communicating regularly with clients but noted that such communication is a ‘two-way street’. “I give responsibility to my clients. They have to make sure they give me important information as well, such as notifying me of any life-changing events like the birth of a child, loss of a job, etc.” Arditi also believes in alerting family members when he notices any deterioration in a
client’s ability to handle or understand their investments. “If I see a decline in mental understanding or similar issues, I will insist on a family member being present. That’s protection for me as well as my client and it reassures the family that the client’s investments are being protected and handled properly,” he stressed.
The Israel/Bayou Fund debacle didn’t surprise Arditi. “Whenever we, as a society, get burned we find a new oven to burn ourselves in later on. In the 1990’s it was the ‘dot.com’ era until that fizzled. Then it was real estate. Now it’s the foreclosure market and hedge funds. People follow fashion instead of sticking to sound principles.” Not following sound investment principles is not the only way local residents lose money or find themselves defrauded out of their life savings.
Individuals can face financial ruin from a variety of life-altering events like medical problems, business losses, and divorce. In the latter
case, financial planners trained specifically in divorce issues can help an af-flicted spouse regain a financial footing. Mary Prior is a divorce planner in Valhalla. She spoke to The Guardian about financial pitfalls that an individual in any type of relationship (business or personal) can fall victim to. “The best way not to be duped is to be an active participant in your fi-nances,” Prior stressed. “People are afraid to speak up and ask questions whether it be to a spouse, a parent, a sibling, or a partner. Sometimes one party needs to be in control so they handle everything. Sometimes the financial duties have just fallen into their lap by default. Other times one party is happily ignorant. Whatever
the reason for the disjointed responsibility, often no conversations about finances ever take place.”
Prior notes that the average person does not need to study the stock market to be able to review their finances. “People simply need to look at what is being spent and how much money they’re taking in. It’s amazing how many people don’t even open their mail and look at their bills!” Women especially fall into this category, Prior noted. “Not only do they not look at the bills, they do not have any dollars set aside for their retirement. I often encounter couples where there was no spousal IRA for the non-working spouse. But women still live longer
than men. Women are still left alone so they should plan accordingly.”
Not taking care of their own needs is not the only area where women fall short when managing their finances, Prior noted. “Far too many spouses sign tax returns without looking at them and understanding them,” she said. “If you’re living a lifestyle that’s not substantiated by your tax return, there’s something wrong. You don’t need to be a tax accountant to review your tax return – a simple look at the first line (income) might be all it takes to uncover hidden funds”. Prior also recommends doing financial checkups regularly, at least once a year.
“Everyone should review the statements they receive at the end of the year to see if they make sense. Look at your annual Social Security statements and run an annual credit report from FreeCredit.com. Also watch your credit cards – those introductory rates may have increased dramatically.” Prior noted that there are plenty of sources for financial advice for individuals.
“All of the major investment houses such as Fidelity, have tons of information online and financial calculators to help individuals determine
how much money they’ll need for retirement, college, whatever”. The New York State Department of State also has a wealth of material available online for investors including an ‘investment quiz’ and complaints lodged against planners, investment houses, and banks. These resources can be found at http://www.oag.state.ny.us/ With the downturn in the economy, many local residents may be seeking ways to offset their declining purchasing power by pursuing questionable investments offering high gains and profits. But, as the Israel/Bayou case showed, even sophisticated investors can be duped and wind up losing their life savings.
All the planners The Guardian spoke with stressed the importance of open communication when it comes to personal finances. As local families feel the stress of higher gas and food prices, an increasing tax burden, and an uncertain business future, financial discussions and open communications become even more critical. The time to sit down and speak with a spouse, a family member, a partner, or a planner, is now.
United States Attorney
Southern District of New York
FOR IMMEDIATE RELEASE
MICHAEL J. GARCIA, the United States Attorney for the Southern District of New York, JOSEPH R. GUCCIONE, the United States Marshal for the Southern District of New York, and MARK J. MERSHON, the Assistant Director-in-Charge of the New York Field Office of the Federal Bureau of Investigation, announced that SAMUEL ISRAEL III surrendered to law enforcement authorities in Southwick, Massachusetts, earlier this morning. On June 9, 2008, ISRAEL failed to surrender to begin serving a 20-year prison sentence for fraudulently inducing investments in the Bayou hedge funds of over $450 million.
Today, at approximately 9:15 a.m., ISRAEL surrendered to officers of the Southwick, Massachusetts, Police Department.
The United States Marshals Service will transfer ISRAEL to the United States District Courthouse in Springfield, Massachusetts, where he will appear before United States District Judge MICHAEL A. PONSOR at 3 p.m.
Mr. GARCIA praised the United States Marshals Service for its extraordinary efforts leading to Israel’s surrender. Mr. GARCIA also praised the extraordinary work of the Federal Bureau of Investigation, which investigated the underlying fraud and worked with the United States Marshals in investigating ISRAEL's disappearance. Mr. GARCIA also thanked the New York State Police and the Southwick, Massachusetts, Police Department.