Securities Fraud Attorney Blog

Below is a piece by Bloomberg on our firm's $383 million claim against Citigroup. There's more on this case on the firm's website at http://www.riklawfirm.com/

Citigroup’s Mathur Said to Depart With Hybrid Traders as Pandit Cuts Jobs
By Donal Griffin - Dec 9, 2011

Citigroup Inc. (C), the third-biggest U.S. bank, is shrinking a team of traders who deal in “hybrid” products as Chief Executive Officer Vikram Pandit cuts Wall Street jobs, two people familiar with the matter said.

Samir Mathur, former head of hybrid trading, is leaving the New York-based firm and is in talks to join a hedge fund, according to one of the people, who asked to remain anonymous because the move hasn’t been announced. Other members of the desk who reported to him, including Yontcho Valtchev, Vivek Kapoor, Eric Kim, Sean Corrigan and Allison Niiya, also are leaving, the person said.

Mathur is among ex-members of the desk who are at the center of a dispute with Ghazi Abbar, a former customer from Jeddah, Saudi Arabia. Abbar claims he lost $383 million of his family’s fortune when Citigroup sold him products that later soured, even though the bank internally questioned his ability to properly manage some of them. Pandit, 54, is shrinking the desk as he cuts 4,500 jobs amid a revenue slump.

“It makes sense for Citigroup to reduce the size of its sales trading activities, particularly in developed markets,” Richard Staite, an analyst at Atlantic Equities LLP, wrote in a Dec. 7 note to clients. “We believe a shift away from trading toward lower-risk consumer and corporate banking may lead to a higher valuation multiple.”

Mathur follows Erwin Parviz, the former London-based head of hybrid structuring who left Citigroup in June, according to U.K. Financial Services Authority records.

Investment Banking

Planned layoffs will include about 900 from the division that contains trading and investment banking, a person familiar with the matter said last month.

Danielle Romero-Apsilos, a Citigroup spokeswoman, declined to comment. Members of the hybrid team didn’t respond to phone messages, said they couldn’t comment or couldn’t be located for comment. Citigroup, with 267,000 employees worldwide as of Sept. 30, is the third-biggest U.S. bank by assets behind JPMorgan Chase & Co. and Bank of America Corp.

Mathur’s team traded hybrid derivatives, financial instruments that derive their values from different underlying assets. Buyers seek to profit from the performance of assets, such as a stake in a hedge fund, without directly owning them. The desk often sold products to large investment firms including Man Group Plc (EMG) and Tudor Investment Corp., people familiar with the matter said last month.
Taxpayer Bailout

Mathur helped to create one of Abbar’s transactions, according to an arbitration claim Abbar has filed with the Financial Industry Regulatory Authority. The bank denies the allegations and has sued Abbar to block the arbitration.

Mathur has worked as a trader for Citigroup since 1998, according to Finra records. He rose to become head of hybrid trading before the bank almost collapsed in 2008 and received a $45 billion taxpayer bailout.

Colleagues of Mathur’s also are Wall Street veterans, Finra records show. Valtchev had worked for Citigroup since 2005 after stints with Deutsche Bank AG and Barclays Plc (BARC), while Kapoor joined in 2007 after working at UBS AG, Credit Suisse Group AG (CSGN) and Standard & Poor’s. Niiya had worked for Citigroup since 2000, according to the records. While most are traders, Kim is an analyst.

Below is an American Lawyer piece which explains our clients' pending $383 million FINRA arbitration against Citigroup. It goes on to talk about how there are more and more large and complex cases at FINRA. It's true. As partner John Rich points out at the end of the article, our firm is involved in other multi-million dollar matters at FINRA. In fact, we handled the Bayou v. Goldman FINRA arbitration case which generated a $20.6 million award, and is mentioned in the article. We think FINRA arbitration will continue to attract sophisticated legal disputes because it is more efficient and timely than court litigation.

Too Big for Their Britches?

Nate Raymond

The American Lawyer

12-01-2011

Just a few years ago, the Abbar family of Saudi Arabia could point to at least $383 million in investments managed by Citigroup Inc. Patriarch Abdullah Abbar and his son Ghazi had built the family fortune through an array of food import, travel, oil transport, and investment businesses. And beginning in 2006, they entrusted the bulk of their wealth to Citi.

Today the relationship has soured, and the money is almost gone. Both sides have lawyered up—the Abbars hired John Rich of Rich, Intelisano & Katz, and Citi retained Scott Edelman of Milbank, Tweed, Hadley & McCloy—and the legal battle is heating up. In August the Abbars filed a securities arbitration claim with the Financial Industry Regulatory Authority ­(FINRA), the U.S. securities industry's self-regulator. But while defendants often prefer the privacy arbitration affords, Citigroup wants to move the case into the courtroom.

The Abbar complaint is one of roughly 200 pending FINRA cases with at least $10 million at stake. The number of cases and the size of potential awards increased significantly after the stock market collapse in 2008. Before then, most FINRA cases involved small investors who were suing their brokers. But after the crash, richer investors flooded ­FINRA with claims that they were duped by large institutions. "The claims coming in now are substantially larger than what we had a few years ago," says Linda Fienberg, president of FINRA's dispute resolution unit.

The financial institutions, faced with hefty awards that are near impossible to overturn, have taken notice. Lawsuits by banks challenging the arbitrations are increasingly common, often contending that sophisticated investors are trying to twist FINRA's original definition of a brokerage customer to include their claims.

Established in 2007, FINRA is the result of a merger of two sets of self-regulatory organizations, the New York Stock Exchange's enforcement arm and the National Association of Securities Dealers. Cases number in the thousands annually, and currently 7,000 claims are pending, Fienberg says.

For most parties in FINRA cases, arbitration offers a quick and private venue to deal with securities claims. But the arbitration landscape changed when financial service firms began teetering. "There were some very large losses during that period," says Jonathan Harris, a commercial litigation partner at New York's Harris, Cutler & Houghteling.

Harris is counsel to Woodside, California, investment management firm Aurum STS Aggressive Trading LLC. During the fall of 2008, Harris and his cocounsel at Steptoe & Johnson contend that Société Générale breached agreements on warrants the bank issued to Aurum in 2003 and 2004, and unilaterally imposed new terms. Aurum filed an arbitration claim in June 2009 against SocGen, and in October a three-arbitrator panel awarded the company $61 million—the second-largest award this year. SocGen has said that it disagrees with the decision, but its lawyers at Latham & Watkins have not sought to vacate it.

Big awards like Aurum's have become more common in the wake of the subprime meltdown. Six of the ten largest securities arbitration awards were handed down during the last two years, according to Securities Arbitration Commentator Inc. In February 2009 FINRA awarded $406.6 million to ­STMicroelectronics N.V. in a fight with Credit Suisse Group AG, followed by a $80.8 million award to Kajeet Inc. against UBS AG in August 2010, and a $54.1 million payout to Colorado patent litigator Gerald Hosier and others in April 2011 over a squabble with Citigroup.

The largest award of 2011 involved options trading firm Rosen Capital Management LLC, which lost $90 million in fall 2008. Rosen's lawyers at Quinn Emanuel Urquhart & Sullivan blamed its prime broker Merrill Lynch & Co., Inc., which had placed ill-fated margin calls amid a crisis that had just weeks earlier thrown it into a government-brokered $50 billion sale to Bank of America Corporation. In July a three-arbitrator panel awarded Rosen $63.7 million. Merrill's lawyers at Wilmer Cutler Pickering Hale and Dorr moved in August to vacate the award.

Courts, though, rarely overturn arbitration awards. The Goldman Sachs Group, Inc. and its lawyers at Schulte Roth & Zabel unsuccessfully fought to vacate a $20.6 million FINRA award that resulted from the bank's alleged failure to detect fraud at the bankrupt hedge fund Bayou Group LLC. In November 2010 Manhattan federal district court judge Jed Rakoff denied Goldman's petition, saying that "having voluntarily chosen to avail itself of this wondrous alternative to the rule of reason, [Goldman] must suffer the consequences."

Banks are fighting over who is permitted to bring claims to ­FINRA. UBS's lawyers at Debevoise & Plimpton, with the backing of the Securities Industry and Financial Markets Association, argued that West Virginia University Hospitals, Inc., as an issuer, could not force the bank, as an underwriter, to arbitrate claims of more than $329 million in auction-rate securities. But in September the U.S. Court of Appeals for the Second Circuit rejected that narrow reading of who FINRA defines as a "customer."

In the Abbar case, Citigroup has similarly filed a lawsuit in Manhattan federal district court seeking to enjoin the arbitration. Milbank's Edelman, Citi's lawyer, declined to comment. But Citi in a statement says the Abbars were not clients of the U.S.–based broker-dealer Citigroup Global Markets Inc., so "their claims should not be subject to FINRA arbitration."

In the meantime, FINRA is adjusting to the bigger cases. In early 2012 it plans to implement a pilot program designed for cases with more than $5 million at stake, Fienberg says. The program, which will be tested in the Northeast and on the West Coast, will formalize the ways that FINRA ­allows parties to modify arbitration procedures. For example, parties could pick arbitrators who do not normally handle FINRA cases, such as former judges. Parties could agree to take depositions, which FINRA generally does not allow. And both parties would be able to pay arbitrators more than the $200 honorarium FINRA typically pays per hearing, a relief to some lawyers who worry about how the low pay might affect the complex cases.

And the Abbars' lawyer? Rich promises more cases from himself as well. "We have other multimillion-dollar cases in the works," he says. "This is not going to be an anomaly."
E-mail: nraymond@alm.com

Top Five Securities Arbitration Awards
Sanchez et al. v. Enrique Perusquia $429.5M
STMicroelectronics N.V. v. Credit Suisse Securities (USA) LLC 406.6M
Kajeet Inc. v. UBS Financial Services Inc. 80.8M
212 Investment Corp. et al. v. Myron Kaplan 74.8M
Rosen Capital Partners LPv. Merrill Lynch Professional Clearing Corp. 63.7M
Source: Securities Arbitration Commentator Inc.

Below is Bloomberg piece about our client's $383 million FINRA arbitration claim against Citigroup Global Markets, Inc. related to hedge funds, private equity, and derivatives.

Bloomberg

Citigroup Saudi Deal Haunts Pandit
By Donal Griffin - Nov 30, 2011

Saudi businessman Ghazi Abbar, who claims in an affidavit he lost $383 million of his family’s fortune on investments with Citigroup Inc., was sold one of the transactions even though the bank questioned his ability to properly manage them, according to an internal memo.

The memo, an exhibit in arbitration proceedings with the Financial Industry Regulatory Authority, warned that Abbar didn’t have the risk-management capability of the large hedge funds that were typical clients of the bank’s “hybrid” desk, which in 2006 was trying to persuade him to move his family’s money into complex derivative securities.

Soured deals struck with wealthy clients are haunting Citigroup Chief Executive Officer Vikram Pandit. Finra awarded $54 million in April to customers of the New York-based bank’s municipal-bond hedge funds, and in February, Brazilian investor Bernardo Valentini sued the bank, claiming he lost more than $24 million on derivatives Citigroup told him had “no risk of loss.”

“The case is a setback in Pandit’s vision of delivering financial services with a higher sense of responsibility to customers,” said David Knutson, a credit analyst with Legal & General Investment Management in Chicago. “As each issue bubbles up, analysts or providers of capital to the firm have to say, ‘OK, what other tape bombs are lying in the dusty lines of Citi’s balance sheet?’”
Citigroup’s Lawsuit

Citigroup denies Abbar’s allegations, saying in a lawsuit that he was a sophisticated investor who knew the risks when he turned over control of his hedge-fund investments to the bank in exchange for derivatives that mimicked their performance. The bank has sued its former client in federal court in Manhattan to block the arbitration, arguing Finra has no jurisdiction because the deals were handled outside the U.S.

Danielle Romero-Apsilos, a Citigroup spokeswoman, declined to comment further.

According to the Finra claim, Citigroup had never before sold the investment idea to individual investors like Abbar, 56, whose family made its fortune in Saudi Arabia importing food and building businesses linked to tourism, aviation, cold storage, ship bunkering and oil. The hybrid team, which also arranged loans when clients wanted to leverage their bets, made about $200 million for the New York-based bank in 2007, people familiar with matter said.

Based in Jeddah, a port city on the Red Sea about 50 miles from Mecca, the Abbars were among the largest merchants in Saudi Arabia, with annual revenue of about $500 million, according to the internal memo. Family members had served in senior positions under the kingdom’s late rulers, kings Faisal and Saud, according to the memo.
Pandit Meeting

Citigroup executives lined up to court Abbar, who oversaw the family’s investments, according to the Finra complaint. Pandit, 54, met with Abbar after joining Citigroup in 2007 as part of the company’s effort to maintain a relationship with the family. So did Chief Operating Officer John Havens, former wealth management boss Sallie Krawcheck and current global markets head Francisco “Paco” Ybarra, according to the complaint.

Abbar moved about $350 million of his family’s wealth to Citigroup from Deutsche Bank AG (DBK) in 2006, and Citigroup rewarded the banker who persuaded Abbar to make the shift, Mohanned “Ned” Noor, with a trip to Hawaii, according to the claim. Abbar was introduced to the hybrid desk, which was growing under Pandit’s predecessor, Charles “Chuck” Prince. Prince was trying to boost revenue by taking more trading risk.
Burns, Mathur

The hybrid group was run by Richard Burns, a London-based Citigroup veteran, according to two people familiar with the group who asked not to be named because they aren’t authorized to speak about the matter. Burns oversaw structuring and trading of hybrid derivatives, securities whose values are tied to different kinds of underlying assets. Samir Mathur was head of hybrid trading for the group.

Abbar wanted a “simple loan structure” to finance some of the family’s hedge-fund investments, he claims. Over meals in restaurants in London and New York, the hybrid team persuaded Abbar to instead transfer control of some of those assets to Citigroup, according to one of the people familiar with the matter. The desk then created the hybrid derivative that would mimic the performance of those funds.

Abbar claims he invested $383 million in the product and a separate private-equity financing deal, which included funds he injected after his initial transfer from Deutsche Bank. Both transactions collapsed after markets plunged in late 2008.
Tiger Management

Abbar had more experience with hedge funds than most. He began investing his family’s fortune after he graduated with a master’s degree in business administration from Harvard University in 1978. He built close relationships with hedge-fund managers such as Julian Robertson of Tiger Management LLC and joined the board of one of the Tiger funds in 1997, according to Fraser Seitel, a spokesman for Tiger Management. Abbar said he also had relationships with Stephen Cohen, founder of SAC Capital Partners LP, billionaire Paul Tudor Jones and Louis Moore Bacon.

Still, as an individual, he was an unusual client for the desk, which typically dealt with large hedge funds and so-called fund of funds firms that make bets on other investment funds. Customers included Man Group Plc (EMG), the world’s biggest hedge fund; Tudor Investment Corp., Tudor Jones’s hedge fund; and Saudi Arabian financial-services firm Saad Group, according to the people familiar with the matter. Abbar didn’t have those firms’ resources, the bank said in the memo.
Operates ‘Alone’

“The Client is not like the typical fund of funds client the desk is used to dealing with,” according to the memo. “The Client does not maintain the extensive risk, due diligence and operational infrastructure that exists at most of the larger fund of funds. While Ghazi is experienced with alternative investments, he operates more or less alone with advice from his friends and industry contacts.”

Abbar’s lack of risk management concerned some Citigroup executives before he bought the product, according to one person familiar with the deal. Members of the hybrid desk concluded that his financial experience gave him the ability to manage the risks, and the bank approved the deal.

“Ghazi has the ability to understand the risks and rewards of the transactions,” Citigroup wrote in the internal memo.

After the deal went through, members of the hybrid team were encouraged to sell similar products to other wealthy individuals, according to the person, who didn’t want to be named because the matter is private.
Hedge Funds

Abbar’s hedge-fund investment collapsed in 2008 as Lehman Brothers Holdings Inc. failed and funds around the world plunged. The Eurekahedge Hedge Fund Index dropped almost 12 percent in the second half of the year, Bloomberg data show. Many investors who used derivatives to multiply their bets were wiped out, according to Satyajit Das, author of “Extreme Money: Masters of the Universe and the Cult of Risk” (FT Press, 2011).

The leverage used to increase derivatives bets “is like playing Russian roulette with six bullets in the chamber,” said Das, who isn’t familiar with Abbar’s case.

The failed investments erased the “considerable family wealth” the Abbars had placed with the bank and damaged relationships within the family, according to the claim. Citigroup now stands to gain $70 million as it sells off the hedge-fund assets at the center of the product, Abbar alleges.
‘Nuclear’ Products

“A lot of these highly leveraged, highly structured products, I analogize them to nuclear power,” said John Lovi, an attorney with Steptoe & Johnson LLP who handles cases involving derivatives and isn’t involved in the Abbar case. “There’s no doubt that it’s complicated and you better have your best and brightest on it and be watching it closely because when it goes bad, it goes really bad.”

The collapse of the deal came as Citigroup itself was posting record losses caused by the financial crisis and its investments in collateralized debt obligations, another form of derivative. The bank lost a total of $29.3 billion in 2008 and 2009 and took a $45 billion taxpayer bailout. Senior executives allowed their hunt for more revenue to eclipse proper risk management, according to a 2008 Federal Reserve Bank of New York inspection report.

Pandit, who took the top job in December 2007, disbanded part of the hybrid team in 2008 and began to wind down the structuring side of the business, the people said. He has since begun an effort to convince investors that the bank’s culture has changed to one of “responsible finance.”
New Team

“We have a new management team, a new governance structure,” Pandit said in a video on the bank’s website, called new.citi.com. “We’re completely focused around the client. Each and every one of our businesses is structured and always thinks about what is it that my clients need and how do I make sure I deliver all of Citi to each and every one of my clients.”

Citigroup advanced $1.44, or 5.7 percent, to $26.68 at 10:46 a.m. in New York trading. The shares slid 47 percent this year through yesterday, compared with a 32 percent drop in the 24-company KBW Bank Index. (BKX)

Abbar is seeking $383 million. The largest award ever granted by Finra was $406.6 million for STMicroelectronics NV against Credit Suisse Group AG (CS) in 2009, according to Finra records.

Citigroup was on the wrong side of the largest award for individual investors in April, when Finra ruled in favor of a group of wealthy, Aspen, Colorado-based customers’ $54 million claim, the records show. The clients said Citigroup misled them about the level of risk tied to investments in the bank’s municipal-bond hedge funds.
‘Guaranteed’ Investment

In a suit brought in Manhattan federal court, Brazilian client Bernardo Valentini claims he lost more than $24 million on derivatives the bank told him were “guaranteed.” He was convinced of the merits of the deal by two Citigroup private bankers, who visited his office in Curitiba and said they “wanted to get to know him,” he said in the court filings. Citigroup denied the allegations.

Banks that sell complex derivatives to wealthy customers often face complaints when the deals don’t work out as planned, said Das, the banker turned author.

“Clients are always good winners,” Das said. “The moment they lose money, they suffer a 100-point drop in IQ.”
Food Imports

Today, Abbar runs the largest of the family’s businesses, Abbar Cold Stores, which imports frozen foods, fresh fruits and cheeses into Saudi Arabia, according to John Rich, an attorney in New York with Rich, Intelisano & Katz LLP, which represents the family.

Some of the executives mentioned in the case have since left Citigroup, including Ned Noor, the Geneva-based private banker who persuaded Abbar to move his money to the bank in the first place. He declined to comment on Abbar’s claims.

Richard Burns and Samir Mathur continue to work in derivatives for Citigroup. They also declined to comment.

The Abbar case is Citigroup Global Markets Inc. v. Abbar, 11-CV-6993; the Valentini case is Valentini et al v. Citigroup Inc. (C) et al, 11-CV-01355. Both cases are in U.S. District Court, Southern District of New York (Manhattan).

Below is a Bloomberg article about our firm's $20.6 million FINRA arbitration award against Goldman Sachs related to Bayou. It's the largest arbitration award ever rendered against Goldman. The award was confirmed by Judge Rakoff and Goldman filed it's brief to the Second Circuit.

Goldman Sachs Asks Court to Throw Out $20.5 Million Bayou Creditors’ Award
By Bob Van Voris - Oct 15, 2011

Goldman Sachs Group Inc. (GS) filed an appeal seeking to dismiss a $20.5 million arbitration award to creditors of the failed hedge fund firm Bayou Group LLC.

Goldman Sachs asked the U.S. Court of Appeals in Manhattan to overrule a decision by the Financial Industry Regulatory Authority, the independent regulatory group for the securities industry. A federal district judge declined in November 2010 to reverse the Finra award.

The creditors sued Goldman Sachs Execution and Clearing LP in 2008 for its role as the prime broker and clearing broker for Bayou’s hedge funds. They said the Goldman Sachs unit aided a $400 million fraud at Stamford, Connecticut-based Bayou, which filed for bankruptcy in May 2006. Bayou co-founder Samuel Israel pleaded guilty to directing the scheme and is serving a 22-year prison term.

In the November ruling, U.S. District Judge Jed Rakoff in Manhattan said Goldman Sachs failed to show that the arbitration panel had “manifestly disregarded the law” in granting the award.

Goldman Sachs, based in New York, argued in its appeal brief that the Finra panel was wrong in determining that deposits into Bayou’s accounts and internal bookkeeping entries qualified as fraudulent transfers.

John Rich, a lawyer for the Bayou creditors, didn’t immediately return a voice-mail message seeking comment yesterday on the Goldman Sachs filing.
Fellow Inmate

Israel is incarcerated at the same federal prison complex in Butner, North Carolina, as Bernard Madoff, who is serving a 150-year sentence for orchestrating the biggest Ponzi scheme in history.

In addition to a 20-year term for the fraud, Israel’s term was extended by two years after he attempted to make it appear that he had committed suicide by jumping off a bridge on the day he was to report to prison.

The case is Goldman Sachs Execution & Clearing LP v. Official Unsecured Creditors’ Committee of Bayou Group LLC, 10- cv-05622, U.S. District Court, Southern District of New York (Manhattan).

Below is a WSJ article about our firm's $20.6 million FINRA arbitration award against Goldman Sachs related to the Bayou hedge fund fraud. It is the largest arbitration award ever rendered against Goldman. The award was confirmed by Judge Rakoff of the SDNY in November 2010 and Goldman filed it's brief to the Second Circuit this week.

Goldman Continues to Fight $20.5 Million Award in Pivotal Case
By LIZ MOYER

NEW YORK—Goldman Sachs Group Inc. is continuing to fight a $20.5 million arbitration award that, while relatively small from the big bank's perspective, has broader implications for Wall Street.

The award stems from Goldman's role as a clearing broker for a failed hedge fund. Goldman filed an appeal Thursday in the U.S. Court of Appeals in the Second Circuit, arguing as it did last fall in district court that the Financial Industry Regulatory Authority arbitration panel that awarded the sum ignored the law.

On the opposite side are the creditors of Bayou Group LLC, which accused Goldman Sachs Execution & Clearing LP of ignoring signs of fraud at the hedge fund run by Samuel Israel III before it imploded in 2005.

A Finra panel awarded the Bayou creditors $20.5 million in June 2010. Goldman sued to vacate the arbitration award in July 2010, but Federal Judge Jed Rakoff confirmed the award in November.

Ross Intelisano, a lawyer for the Bayou creditors at Rich, Intelisano & Katz, said investors are "frustrated" by the delay in receiving their money. "We're looking forward to the Second Circuit reconfirming the arbitration award," he said.

The disputed case comes as regulators are eager to lay blame after the financial crisis exposed rampant cases of Ponzi schemes and other frauds. The $20.5 million award, if it is upheld, could raise the standards of care required by banks that clear trades for hedge funds, lawyers said.

The Securities Industry and Financial Markets Association, an industry group representing Wall Street sided with Goldman in district court last year and plans to file a brief in support of Goldman in the appeal, a spokesman said.

In May, Goldman said the Commodity Futures Trading Commission had "orally advised" it that it faced civil fraud charges over its role clearing trades for an unnamed client. Goldman said it was cooperating.

In that probe, the potential charges concern whether Goldman knew or should have known the client was using customer accounts in transactions with Goldman rather than the client's own accounts.

In the Bayou case, the creditors argued that the hedge fund's depositing of money into its account at Goldman, and then its shuffling around of that money among accounts, constituted transfers to Goldman that could be recovered by investors.

The creditors also accused Goldman of ignoring several warning signs, including suspicious money transfers. About $13.9 million of the award concerns money Bayou moved among its accounts.

Bayou was founded in 1996 and exposed as a $400 million fraud in 2005. Goldman was a prime broker and clearing firm for Bayou from 1999 to 2005. Mr. Israel, who went on the lam briefly, is currently serving a 22-year prison sentence.

Dan Carlson, a San Diego lawyer who represents investors in Finra arbitrations, said the financial crisis has "opened eyes that clearing firms and brokerages need to be doing more due diligence."

Wall Street firms have argued that extra due diligence will slow down business and increase costs. "In imposing liability on Goldman, the arbitrators disregarded the long-recognized principle that a clearing firm cannot be liable for merely processing transactions received from an authorized source," Sifma wrote in its friend of the court brief siding with Goldman in district court last fall.

"If clearing firms were required to analyze trading in introduced accounts," Sifma added, "the speed and efficiency demanded in the contemporary securities markets would not be possible."

Below is an On Wall Street piece about our firm's representation of a Saudi investor in a $383 million FINRA arbitration against Citigroup Global Markets, Inc.

Citigroup Aims to Stop Arbitration From Proceeding
By Lorie Konish, On Wall Street
October 7, 2011

A new lawsuit filed by Citigroup Global Markets Inc. this week against a set of Saudi family investors with a $383 million claim against the firm will determine whether that case can proceed to arbitration.

Citigroup’s suit, dated Oct. 5, is aimed at putting a stop to the arbitration case filed with the Financial Industry Regulatory Authority in August by Abdullah Abbar and Ghazi Abbar, father and son Saudi nationals.

Citigroup claims that the Abbars were not clients of the U.S.-based broker-dealer Citigroup Global Markets Inc., which was named in the arbitration suit the pair filed with the Financial Industry Regulatory Authority in August. Instead, the private equity and hedge fund investments cited in the arbitration—investments the Abbars took part in during the years 2006 and 2007—came from Citigroup entities in the Cayman Islands, Switzerland and United Kingdom, the firm said.

Those entities are not subject to FINRA rules because they are located outside of the United States.

"We are confident this matter will be appropriately resolved when it is reviewed by legal authorities in the jurisdictions that the parties agreed to when they executed their trades,” Citigroup Spokeswoman Natalie Marin stated via email on Wednesday. “Because Citigroup Global Market Inc. was not a party to the trades in question and because the claimants were not customers of Citigroup Global Markets Inc., their claims should not be subject to FINRA arbitration."

But the Abbars, who are represented by New York-based law firm Rich & Intelisano LLP, disagree. The next step will probably be an oral argument over whether there should be a temporary restraining order stopping the arbitration, Ross B. Intelisano, a partner with the law firm, said.

“If we win in arguing to the Southern district that the arbitration should go forward, then the arbitration will go forward or Citigroup may appeal up to the Second Circuit,” Intelisano said. “If we win that, then we’ll have an arbitration.”

Intelisano plans to fight Citigroup’s claims based on the fact that the New York entity and its employees were the ones that sold the Abbars the investments. “We’re arguing that they’re attempting to evade their regulatory responsibility as a registered brokerage firm to arbitrate these disputes if the customer chooses to do so,” Intelisano said.

Clients who bring cases to FINRA also have the option of resolving disputes through mediation.

Another recent case, including UBS AG versus a West Virginia hospital, also called into question the definition of a customer and if a case can proceed to arbitration, Intelisano said. That case was ultimately sent to arbitration.

If the Abbars’ arbitration proceeds, the case will address their initial claims that misconduct by Citigroup Global Markets and its employees “virtually wiped out” the Abbars fortune that totaled about $350 million as of 2005, their August claim said.

The Abbars’ fortune came mostly from food products importing, as well as other businesses including oil investments and travel and tourism. Most of those assets were invested in hedge funds, with other investments in real estate trusts, private bond issues, private equity, public equities and bonds, real estate trusts and venture capital.

The family was wooed to work with Citigroup after a financial advisor they were working with at Deutsche Bank joined that firm. By luring the Abbars to Citigroup, that banker became a top private banker at the firm and the Abbars became one of the firm’s top ten international clients, according to the Abbars’ arbitration filing.

The investments cited in the arbitration dispute include two leveraged option transactions that had a leveraged exposure to multiple hedge funds, as well as another private equity transaction involving a unit trust and related loan.

"The crux of our case is that Citigroup sold a very, very complex product to a wealthy family that was really not appropriate for a non-institutional client," Intelisano said. "Citigroup had previously only sold these complex structures to funds of funds and hedge funds prior to selling it to our clients."

After banks and brokerage firms began selling complex derivative products to individuals and families in addition to the institutions they were originally targeted for around 2006 and 2007, more cases like this could crop up, according to Intelisano.

"I think you will see other cases filed involving retail investors who were improperly sold inappropriate institutional products by banks worldwide,” Intelisano said.

Below is a story about CGMI's attempt to stay a $383 million FINRA arbitration filed by our firm related to inappropriate behavior with respect to derivatives, hedge funds, and private equity transactions.

Oct. 6 (Bloomberg) -- A Citigroup Inc. unit sued two Saudi investors seeking to block Financial Industry Regulatory Authority arbitration of their $383 million claim that the bank “wiped out” their family’s wealth.

Abdullah and Ghazi Abbar, a father and son from Jeddah who put family money into hedge funds, have no customer agreements or accounts with Citigroup Global Markets Inc., a New York-based broker dealer that they blame for mismanaging their family’s life savings, according to a complaint the Citigroup unit filed yesterday in federal court in Manhattan.

The Citigroup entities that handled two leveraged option transactions and a private-equity loan for the Abbars are based in the U.K., Switzerland and the Cayman Islands and aren’t subject to arbitration by Finra, a Washington-based brokerage regulator, according to the complaint.

“We are confident this matter will be appropriately resolved when it is reviewed by legal authorities in the jurisdictions that the parties agreed to when they executed their trades,” Natalie Marin, a spokeswoman for New York-based Citigroup, said in an e-mail.

John Rich, an attorney for the Abbars, didn’t immediately return a voice-mail message left after regular business hours seeking comment on the lawsuit.

The Abbars, whose money comes from food products importing, travel and tourism, oil investments and other businesses, were courted by top bank officers, including Chief Executive Officer Vikram Pandit and former global wealth management chief Sallie Krawcheck, to maintain or expand business with the New York- based company, they said in their Finra claim.

‘Gross Misconduct’

“Due to a pattern of gross misconduct by CGMI and its employees and affiliates, from late 2005 to present, the considerable family wealth which the Abbars entrusted to Citigroup has been virtually wiped out,” the Abbars said in the claim they filed with Finra on Aug. 17.

The Abbars said their family was lured to Citigroup in 2006 after their Deutsche Bank AG banker moved to Citi Private Bank Geneva. The Abbars put $343 million of their hedge fund investment assets into a leveraged option swap transaction to which Citigroup’s London affiliate was a last-minute counterparty, a move designed to shield the bank from U.S. regulatory and legal obligations, according to the claim.

Voting Shares

As part of the hedge-fund financing transaction, Citigroup Global Markets had all the voting shares of the entities that held the family’s investments. The bank failed to monitor the investments, which became over-leveraged and totally collapsed in late 2008 when the full force of the financial crisis hit, the Abbars alleged.

“Citigroup took over management of the remaining positions in the hedge fund portfolio and put in place a program for redeeming the entire portfolio,” they said in the Finra claim. “Citigroup will unjustly benefit in the amount of approximately $70 million from redemption of such investments after repayment of the loan and interest.”

The Abbars also set up a credit facility with Citigroup under Cayman law providing for loans of as much as $110 million and were persuaded to use the facility to invest in bank-related private-equity investments. The Citigroup entities involved in the day to day management of the credit deal “were ultimately responsible” to Finra-registered personnel in New York, they said in the claim. They said the credit structure eventually collapsed because of borrowings related to the Citigroup investments.

The Abbars seek damages of $147 million in connection with a credit facility that was set up to pay for capital calls in the family’s private-equity investments. They are also seeking $198 million tied to the hedge fund transaction and recovery of $38 million they injected into the Citigroup deals, according to their claim.

The case is Citigroup Global Markets v. Abbar, 11-6993, U.S. District Court, Southern District of New York (Manhattan).

--With assistance from Donal Griffin and Bob Van Voris in New York. Editors: Peter Blumberg, Andrew Dunn

A Florida FINRA panel awarded $6.4 million to an investor in Citi's MAT municipal bond arbitrage fund this week. It's the largest award rendered against Citi related to its MAT and Falcon proprietary fund blow-ups. The case is Berghorse v. Smith Barney (FINRA 08-04466). Although damages claimed on the award were $12 million, sources say the net out of pocket losses were under $10 million, making the award amount over 64% of the losses. The 29 hearing sessions also make it the longest MAT arbitration to date. This substantial award follows a string of 100% NOP awards rendered against Smith Barney late last year. Below is an On Wall Street piece about the case.

FINRA: Citi To Pay Investors $6.4M
By Lorie Konish
February 9, 2011

A Financial Industry Regulatory Authority panel has ordered two parts of Citigroup Inc. to pay $6.4 million to make up for investment losses tied to a group of troubled municipal arbitrage trust funds.

The $6.4 million award is about half of the compensatory damages requested by the claimants, led by investment banking executive D. Theodore Berghorst, who sought no less than $12 million for costs, attorneys’ fees, rescission and other expenses.

“It’s the largest award to date,” said Ross B. Intelisano, a partner at Rich & Intelisano LLP, a New York law firm handling other cases involving Citigroup’s proprietary MAT and Falcon hedge funds. “I think it’s because of the size of the claim. It’s also the largest in size that’s been tried all the way to a full award.”

FINRA’s decision caps off a string of awards in the last few months related to those Citigroup funds, Intelisano said, while the 29 hearing sessions for this case was longer than most.

The respondents in the cased include Citigroup Global Markets Inc., operating under the name Smith Barney, and Citigroup Alternative Investments LLC. The claim is related to a group of funds, MAT Finance LLC, short for municipal arbitrage trust.

Those funds, which underwent severe losses during the financial downturn, have also come under investigation by the Securities and Exchange Commission after investors charged that the brokers selling them did not fully disclose their risks, The Wall Street Journal reported in November. The MAT funds were modeled to reap gains by investing in long-term bonds, but reportedly suffered around 80% in losses around 2008.

“We neither confirm nor deny the existence or non-existence of investigations,”

SEC Spokesman Kevin Callahan said regarding the reported investigation of the funds.

The claimants in the case, which was first filed in November 2008, alleged fraud, fraudulent misrepresentations, negligent misrepresentation, breach of fiduciary duty, negligence, breach of contract, and violation of the Florida Securities and Investor Protection Act, among other rules.

The list of claimants include D. Theodore Berghorst, chairman and chief executive of Vector Securities LLC, a health care-focused merchant and investment banking firm; Berghorst Snowbird LLC; Berghorst 1998 Dynamic Trust and Vector Managed Holdings.

With the award decision, Citigroup will pay $6.4 million excluding interest to the claimants. Of that sum, Citigroup Global Markets will pay 75%, while Citigroup Alternative Investments will be responsible for the remaining 25%. The FINRA panel denied the claims related to the Florida statues, citing a lack of proof.

“We disagree with the decision,” Citi Spokesman Alexander Samuelson said.

Berghorst was not available for comment by press time.

Below is a New York Times piece about the Firm's $20.6 million arbitration award against Goldman Sachs being upheld by Judge Rakoff in a sternly written opinion.

DealBook - A Financial News Service of The New York Times
November 30, 2010, 6:16 pm
Goldman's $20 Million Consequence
By SUSANNE CRAIG

Goldman Sachs made its bed. Now Judge Jed S. Rakoff says the Wall Street firm has got to lie in it.

In 2008, Goldman chose to fight a case in arbitration rather than court. On Tuesday, in a sharply worded attack on the system, Judge Rakoff of the United States District Court in Manhattan said that Goldman would have to live with the findings of the arbitration panel. In this instance, those consequences could amount more than $20 million.

"Although arbitration is touted as a quick and cheap alternative to litigation, experience suggests that it can be slow and expensive. But it does have these `advantages'; unlike courts, arbitrators do not have to give reasons for their decisions, and their decisions are essentially unappealable." Judge Rakoff wrote in his opinion. Goldman "having voluntarily chosen to avail itself of this wondrous alternative to the rule of reason, must suffer the consequences."

The case stems from the collapse of the Bayou Group, whose former chief executive, Samuel Israel III, is now serving 20 years for fraud. Goldman cleared trades for the hedge fund for years. In 2008, unsecured creditors of Connecticut-based Bayou filed a claim against Goldman, arguing the firm ignored signs of wrongdoing at Bayou.

Under the terms of its contract with Bayou, Goldman could have applied to fight the case in bankruptcy court. But instead the firm opted for arbitration.

"Both sides could theoretically have agreed to waive the arbitration clause and litigate in court, but either could have insisted on arbitration," says a Goldman spokesman, who declined to comment on the decision.

That strategy didn't pan out. Earlier this year, a three-person Financial Industry Regulatory Authority panel ordered the firm to pay $20.6 million to the unsecured creditors of the Bayou Group.

But Goldman wasn't happy with the findings, and in July it moved to vacate the arbitration award - the largest ever levied against the firm. In taking the matter to court, the firm argued the panel had "manifestly disregarded the law" and exceeded its authority under the Federal Arbitration Act.

In early November, Judge Rakoff denied the request. On Tuesday, he expounded on the matter in a 13-page opinion, taking jabs at both arbitration and Goldman. Judge Rakoff, known for his sharp wit and blunt talk in big Wall Street cases wrote, "a court, unlike an arbitrator, must state its reasons and subject them to appellate scrutiny."

The firm is not out of options yet. It can appeal Judge Rakoff's decision to the Second Circuit Court of Appeals.

If ultimately upheld, the Bayou award could have ramifications across the financial sector. Wall Street firms, which handle billions of dollars in transactions, say that their job is to clear trades, not police clients. This award could raise the standard for clearing businesses.

John G. Rich, a partner at New York law firm Rich & Intelisano who represented the Bayou creditors, said, "The Bayou investors are gratified that the judge gave proper deference to the arbitrators' findings about Goldman's conduct."

Below is a piece by the American Lawyer. Top Story of the day.

TOP STORY November 9, 2010

The Am Law Litigation Daily - Did Goldman Make Bad Gamble With Arbitration Award?

Arbitration / Commercial
Judge Rakoff Confirms $20.6 Million Arbitration Award Against Goldman Sachs
Goldman Sachs isn't known for tactical blunders. Did the banking giant miscalculate by challenging a $20.6 million arbitration award?

That's the question we were left pondering after Manhattan federal district court judge Jed Rakoff confirmed the award, which had been issued by a Financial Industry Regulatory Authority panel in June. (Judge Rakoff's one-page order is here; the judge will issue a more detailed opinion later.) The award was won by the creditors' committee of the Bayou Group, which collapsed in 2005 under the cloud of a $400 million Ponzi scheme orchestrated by its former CEO, Samuel Israel III. In their arbitration claim, Bayou's creditors argued that Goldman, which cleared trades for Bayou, failed to investigate these trades after it learned of potential fraud. Goldman responded that it had no obligation as a prime or clearing broker to detect or report fraud.

The FINRA panel's decision in June got lots of folks on Wall Street gnashing their teeth. The clearing business moves a lot of money and generates plenty of profits for firms like Goldman, and brokers worried that the Bayou award could force them into a policing role and compel them to raise due diligence standards.

Goldman and its lawyers at Shulte, Roth & Zabel filed a lawsuit to vacate the FINRA award in July, arguing that the FINRA panel exceeded its powers "in manifest disregard of the law." The bank got amicus support from the Securities Industry and Financial Markets Association, which asserted that requiring clearing firms to monitor every trade for potential fraud would cripple securities markets. Sidley Austin's Henry Minerop, who authored SIFMA's brief, declined to comment pending an elaborated opinion from Judge Rakoff.

The Bayou creditors' committee, represented by Rich & Intelisano, argued at a September hearing before Judge Rakoff that the FINRA decision was limited to cases in which clearing firms had been notified of a Ponzi-style fraud.

Goldman will hardly miss $20 million. The problem is that while the FINRA decision may have rankled clearing firms, it was not precedential. Depending on the reasoning in Judge Rakoff's more detailed ruling, other clearing firms may wish that Goldman had chosen to write the Bayou creditors a $20.6 million check.

"We've been fighting for a long period of time, and we look forward to the investors getting some of their money back," Ross Intelisano told us. Goldman’s lead lawyer, Shulte Roth’s Howard Schiffman, referred us to his client, which declined to comment.

-- David Bario

Here is a piece from Reuters on the Firm's recent win against Goldman Sachs.

Goldman loses bid to toss record Bayou award
3:46am EST

By Jonathan Stempel

NEW YORK (Reuters) - A federal judge on Monday rejected Goldman Sachs Group Inc's bid to throw out a record $20.6 million (12.8 million pounds) arbitration award involving the now-defunct Bayou hedge fund.

U.S. District Judge Jed Rakoff in Manhattan granted a request by unsecured creditors of Bayou Group LLC to confirm the award, which was made in June by an arbitration panel of the Financial Industry Regulatory Authority.

Creditors had accused a Goldman (GS.N: Quote, Profile, Research, Stock Buzz) unit that cleared trades for Bayou of ignoring signs of fraud at the Connecticut hedge fund.

Bayou was run by Samuel Israel, who is serving a 20-year prison sentence after pleading guilty in 2005 to defrauding investors out of roughly $450 million.

"It's significant," said Ross Intelisano, a partner at Rich & Intelisano LLP, representing the creditors. "It confirms the largest arbitration award ever rendered against Goldman, and provides a significant recovery for investors."

Goldman spokesman Ed Canaday declined to comment. It was not immediately clear whether Goldman plans an appeal.

Rakoff said he will issue a opinion to explain his reasons for upholding the award.

If the award stands, it could increase the requirements that Wall Street banks set before clearing trades for clients.

In court papers, Goldman called the legal foundation for the arbitration award "demonstrably wrong."

Goldman said the law is "crystal clear" that it cannot be liable for money that Bayou deposited into and shuffled among accounts at the bank.

The case is Goldman Sachs Execution & Clearing LP v. Official Unsecured Creditors' Committee of Bayou Group LLC, U.S. District Court, Southern District of New York, No. 10-05622.

(Reporting by Jonathan Stempel. Editing by Robert MacMillan)

Below is a piece from the NY Times' DealBook about Judge Rakoff confirming the $20.6 million arbitration award against Goldman Sachs, the largest arbitration award ever rendered against the firm.

DealBook - A Financial News Service of The New York Times
November 8, 2010, 11:29 am
Judge Upholds Award Against Goldman

A federal judge has denied a request by Goldman Sachs to throw out a record arbitration award levied against the Wall Street firm earlier this year.

Goldman was ordered in June to pay $20.6 million to the unsecured creditors of the Bayou Group, a hedge fund manager, who accused Goldman of ignoring signs of fraud at the firm.

Bayou collapsed in 2005, and the firm’s former chief executive, Samuel Israel III, is serving 20 years for fraud. He pleaded guilty to misrepresenting the value of Bayou’s funds and defrauding clients of more than $400 million.

Goldman cleared trades for Bayou, which was based in Connecticut, before it collapsed. In 2008, Bayou’s unsecured creditors’ committee filed an arbitration claim against Goldman.

Judge Jed S. Rakoff of United States District Court in Lower Manhattan issued an order on Monday, saying a petition by Goldman to vacate the award had been denied.

“After full consideration of the parties’ briefs and oral argument, the court hereby denies the petition to vacate the arbitration award and grants the cross-petition to confirm the award,” he wrote. “However final judgment will not be entered in this case until the court issues an opinion setting forth the reasons for this ruling.”

In July, Goldman moved to vacate the award. During the arbitration, Goldman denied accusations that it had ignored signs of wrongdoing, and it still has more avenues to appeal the award.

A Goldman spokesman declined to comment on Judge Rakoff’s order.

The award was a watershed. If ultimately upheld, it could have ramifications throughout the financial sector. Wall Street firms, which handle billions of dollars in trades, say that their job is to clear the trade, not police the clients. This award could raise the standard for clearing.

“We are looking forward to investors finally getting some of their money back from this tragic fraud,” said Ross Intelisano, a partner at the New York law firm Rich & Intelisano who represented the Bayou creditors.

– Susanne Craig

Below is a piece from the front page of the October 23, 2010 business section of the New York Times regarding the firm's $20.6 million arbitration award against Goldman Sachs, the largest customer arbitration ever rendered against Goldman.

DealBook - A Financial News Service of The New York Times
October 21, 2010, 8:38 pm
In Clearing Bayou, Quagmire for Goldman

By SUSANNE CRAIG

“Did Sam Israel come to the dinner? Has Bayou ramped it up yet?” asked a top Goldman Sachs executive in a 2004 e-mail.

The executive, Duncan L. Niederauer, now head of the New York Stock Exchange, was writing to make sure that Goldman would keep the business of Samuel Israel III, whose hedge fund, the Bayou Group, was paying the firm often millions of dollars in fees a year to clear its trades.

The next year, Bayou collapsed amid fraud investigations. Mr. Israel would later be convicted of defrauding investors of hundreds of millions of dollars and was sentenced to 22 years in prison.

Bayou’s unsecured creditors filed an arbitration contending that Goldman knew for several years that the Connecticut hedge fund was hemorrhaging money even when it was claiming impressive returns.

Now, newly unsealed court documents — including Goldman e-mail and internal reports — portray a firm that at times seemed to turn a blind eye to its own internal concerns about Bayou as it raked in fees from the hedge fund.

During the arbitration, Goldman denied allegations it had ignored signs of wrongdoing. “We have asked the court to review the arbitration panel’s decision and believe it is inappropriate to comment.”

Through a spokesman, Mr. Niederauer declined to comment.

The documents — providing a rare window into a Wall Street firm’s clearing of a hedge fund client — have come to light as a result of litigation involving the unsecured creditors, who have accused Goldman of ignoring signs that the hedge fund was a Ponzi scheme.

In July, Goldman moved to vacate the decision ordering it to pay $20.6 million, the largest investor arbitration award ever levied against the Wall Street firm.

The award was a watershed. If the federal courts uphold the arbitration decision, it could have ramifications across Wall Street. Wall Street firms, which handled billions of dollars in trades, say that their job is to clear the trade, not police the clients.

If the Bayou arbitration award is upheld, Wall Street’s main lobby group, the Securities Industry and Financial Markets Association, has argued it could paralyze trading.

Goldman has its work cut out for it in its move to have the award thrown out. Arbitration awards are rarely overturned by courts and can be vacated only on a handful of grounds: for bias, fraud or if courts find there was “manifest disregard” of the law in the arbitration process.

The award and the unsealed documents could complicate the industry’s position. They show Goldman’s clearing division had at times serious concerns about Bayou, yet failed to alert securities regulators, raising fresh questions about what the obligations of a clearing firm should be.

“Do we care if the Bayou ‘Bayou No Leverage Fund’ uses leverage?” asked a Goldman Sachs executive, Charles Sweeney, in a December 2003 e-mail to two colleagues. Mr. Sweeney, through the Goldman spokesman, declined to comment. A Goldman spokesman said that Bayou’s new account form allowed it to use margin.

Bayou had $89 million in trading losses while a Goldman client, documents show. Those losses translated into big business for Goldman. The firm made $9.5 million from Bayou from 1999 to 2005.

While that is a drop in the bucket for Goldman, which posted a profit of $13.4 billion in 2009, it is significant for the firm’s clearing division. At one point Bayou was a “top 50 clearing client” of Goldman and accounted for 1 percent of all the revenue made by the clearing division, documents show.

Court exhibits and e-mails indicate the firm knew of Bayou’s claims of lofty returns. However, Goldman executives testified during arbitration that they were not aware of Bayou’s assertions of lofty returns.

Goldman’s clearing manual contains a warning to employees about hedge funds, documents show. “If I were going to launder money, I’d use a hedge fund,” wrote Jon S. Corzine, a former Goldman chief executive and now head of the brokerage firm MF Global. “It’s a good way to move large sums of money. There is no supervision, and you don’t have to reveal who your clients are.”

Trading records show Bayou made many large wire transfers, often on the same day. For instance, on Dec. 21, 2004, $1.6 million was wired into Bayou’s no-leverage fund from an account at Wachovia. That same day, five wires went out of the fund for the same amount. The amount came in from one source, and went out to five different ones.

This practice is known as flipping and is suspicious because it could indicate a fund was laundering money. A Goldman spokesman declined to comment, referring instead to testimony by its executives that says its clearing division does not monitor this sort of activity.

Separately, in 2003, Bayou set up four hedge funds for investors, including the no-leverage fund. Goldman executives, however, spotted some funds had similar trading strategies. “Bayou has multiple funds and they tend to all do similar trades,” Mr. Sweeney said in an e-mail in May 2003.

A Goldman spokesman declined to comment, pointing instead to testimony during arbitration where an expert hired by Goldman said that similar strategies in different funds were not uncommon.

Hedge funds often clear through multiple brokerage firms, so losses in one account may not be indicative of the fund’s actual performance. Still, documents show Goldman and Bayou Securities, the hedge fund’s broker-dealer, had an exclusive clearing agreement, which the claimants argued showed Bayou should have been clearing only through Goldman.

A Goldman manager, Kyle Czepiel, told regulators in 2004 during a separate investigation into Bayou’s operations that “the hedge funds never traded away from Bayou Securities,” and Goldman “was the only clearing firm through whom they traded.” During the Bayou arbitration he said that Bayou “might” have traded a few products away from Goldman. Goldman declined to comment.

During the arbitration, the unsecured creditors argued that bankruptcy case law showed that Goldman should be held liable for the losses. One case, Gredd v. Bear Stearns, found that once a clearinghouse was on “inquiry notice” about a possible fraud, meaning it knew or should have known a fraud might have been taking place, it had a responsibility to make a good faith investigation of the suspicious activity.

In the Gredd case, a Bear Stearns executive heard at a party that the Manhattan Investment Fund was reporting big returns to clients. But the executive knew that the fund’s account at Bear was losing money. Eventually Bear notified regulators of the concerns. A jury found Bear should not be held liable for the losses in the fund.

The Gredd case, however, found that to be held liable a clearinghouse has to do more than simply hold the money; it has to exercise some type of control over it. For instance, there may be a margin account, where the clearinghouse has a legal right to access the funds.

“The firm has to do more than simply carry the funds in the customer’s accounts, it has to exercise some discretionary power over the money,” said Henry Minnerop of the law firm Sidley Austin, who wrote a brief in support of Goldman’s motion to vacate the Bayou award.

John G. Rich, a lawyer for the unsecured creditors and a partner at the law firm Rich & Intelisano, said Goldman had the ability to use the funds for its own purpose, and was on inquiry notice about fraud at Bayou, yet did nothing.

“Despite facts showing potential fraud was taking place they put their head in the sand and continued to collect significant commissions from Bayou,” Mr. Rich said.

The Manhattan Fund is different from Bayou in that it constantly had margin debt in its account. Goldman has argued that because Bayou did not have margin debt on the days it was transferring money, Goldman was a mere conduit of the funds and the unsecured creditor’s case was baseless.

Below is a profile of Ross Intelisano from the Spring 2010 edition of the Brooklyn Law School Magazine BLSLaw Notes.

BLSLawNotes
The Magazine of Brooklyn Law School | Spring 2010
Alumni Update
Ross Intelisano ’94: Fighting Fraud from Bear Stearns to Bernie Madoff and Beyond

In 2006, Ross Intelisano made a prediction. A seasoned securities arbitration lawyer with a reputation as one of the leading authorities on securities fraud and Ponzi schemes, Intelisano looked into the future and saw a financial crisis of unimaginable proportion. He put his vision on paper and published an article in Bloomberg Law Reports entitled “Hedge Fund Fraud — The Future of Securities Arbitration?” in which he predicted, one year prior to the Bear Stearns High Grade Funds implosion, that broker-dealers would roll out proprietary hedge funds that were bound to unleash havoc on the financial system. Unfortunately for the market, and for the countless number of investors hurt by Bear Stearns, Intelisano was right.

In 2007, as predicted, Bear Stearns’ High Grade hedge funds crashed, with $1.6 billion in losses. Intelisano was there to pick up the pieces, taking on Bear Stearns on behalf of Racetrac, a multi-billion dollar private company that had lost $5 million in Stearns’ High Grade Structured Credit Strategies Hedge Fund. In December 2009, after a 16-day arbitration in Atlanta, Intelisano won a $3.4 million arbitration award on their behalf. The award was groundbreaking for two reasons: It was the first verdict in any forum relating to the High Grade Funds, and it was rendered after portfolio managers Ralph Cioffi and Matthew Tannin were acquitted in a federal criminal trial.

While the Racetrac arbitration was an historic case, it was not the first time Intelisano had been on the pioneering end of an arbitration. He has long been a crusader for defrauded investors.

After graduating from the Law School in 1994, Intelisano joined Pressman & Associates, a one-man shop where he began to practice securities and employment law. Three years later, he was recruited by Eppenstein & Eppenstein, a premier securities arbitration firm, where he served as co-trial counsel on Engel et. al. v. Refco, the legendary commodities fraud case. The 100-day arbitration, on behalf of 13 individuals and family-run businesses, generated a $43 million judgment in 2001. It remains the largest collected arbitration award ever rendered on behalf of retail investors against a brokerage firm.

In 2003, he joined forces with Eppenstein colleague John G. Rich to form Rich & Intelisano where he continued to try landmark cases, most notably working on behalf of investors who lost over $25 million in the $300 million Bayou hedge fund Ponzi scheme run by convicted fraudster Sam Israel. In Bayou, Intelisano once again did the unprecedented, filing a group arbitration case not against Israel, but against the registered investment advisor who had recommended Bayou to investors, for failure to perform adequate due diligence. The case, which was settled in mediation, was the first time in the world of secu¬rities arbitration that anyone had implicated an investment advisor in a Ponzi scheme.

And then came Bernie Madoff and a Ponzi scheme so large that it dwarfed anything the securities world had ever seen ($18 billion is the latest estimate). Intelisano’s phone started ringing. “I spent hours consoling investors, listening to all of these tragic stories of middle class people who had lost every dime they had saved over a lifetime,” he recalled. “I knew they would never get it back. It was the lowest point of my career as a lawyer.”

While he knew he would not be able to help investors sue Madoff (their restitution is being handled by a court-appointed trustee), he brought back the “investment advisor theory” he advanced in Bayou, and is currently representing a group of 12 victims in claims against investment advisors to Madoff feeder funds. The hearings begin in June.

With the Madoff cases ahead of him, and the victories in Racetrac and Bayou behind him, Intelisano has become one of the country’s most well respected experts in the world of hedge fund fraud. He has appeared on The Today Show, Anderson Cooper 360, Dateline NBC, PBS’s Frontline, Closing Bell with Maria Bartiromo, and is regularly quoted in The New York Times and The Wall Street Journal.

Looking into the future, Intelisano believes the horizon remains clouded over with the potential for serious fraud. “Over-the-counter derivatives, credit default swaps, oil futures, all of these products that the government is worried about regulating are very complex and are improperly being sold to retail and institutional investors. Firms aren’t watching the shop. No one is.”

Prediction noted.

62 • BLSLawNotes

Below is a New York Times Piece about Bayou v. Goldman Sachs

Goldman Must Pay Some Bayou Losses
By LOUISE STORY and GRETCHEN MORGENSON
Goldman Sachs has been ordered to pay $20.58 million to creditors of a failed hedge fund to settle claims that the bank helped the fund perpetrate a Ponzi scheme.
The award represents the first time that a bank has been held accountable for a Ponzi scheme because of its role as a middleman.
Goldman cleared trades and lent money to the Bayou Group, a Connecticut hedge fund that collapsed in 2005, when state and federal investigators said the firm defrauded investors of hundreds of millions of dollars.
The Bayou fraud resurfaced in 2008 when its founder, Samuel Israel III, faked his own suicide after being sentenced to 20 years in prison for fraud. He later turned himself in and is now serving 22 years.
Bayou’s creditors filed a complaint against Goldman two years ago, saying the bank either knew or should have known of Bayou’s fraud. Goldman, the complaint said, had access to Bayou’s trading records, which showed losses, as well as its marketing materials, which showed profits.
The award, in a decision by an arbitration panel of the Financial Industry Regulatory Authority issued on Thursday, may put other banks on notice to better scrutinize their hedge fund clients’ activities.
“This case shows that you can’t just stick your head in the sand when a fraud is going on in your shop,” said Ross B. Intelisano, a lawyer at Rich & Intelisano, who brought the arbitration against Goldman. The bank “argued that you could, and the panel disagreed.”
A Goldman spokesman pointed to the bank’s filing in the case, which questioned whether the creditors could use bankruptcy laws to hold Goldman accountable for the $20.58 million of investor money that Bayou transferred among its Goldman accounts. The money was never actually conveyed to Goldman, the bank said, so it should not be considered a fraudulent transfer.
The arbitration panel does not determine whether wrongdoing occurred, but merely decides on compensation.
“We are disappointed with the award and are considering our options,” said Ed Canaday, a spokesman for Goldman.
Goldman has limited grounds for vacating an arbitration award, however.
The award to Bayou’s creditors is yet another legal woe for Goldman. The bank is also the target of a Securities and Exchange Commission investigation of its mortgage operations before and during the financial crisis, and Goldman is fighting an S.E.C. complaint and private lawsuits about mortgage securities it created. Goldman has defended its actions in the mortgage market and said the parties that purchased its mortgage deals should have known what they were dealing with.
Although the Bayou case dates long before the financial crisis and has nothing to do with mortgage bonds, Goldman made similar claims in its reply. The bank, for instance, said the creditors of Bayou were “highly sophisticated investors.” Goldman also said it had no duty to monitor the “honesty and the finances” of its account holders.
Goldman served as Bayou’s main prime broker from 1999 to 2005, meaning that the bank had a wide view of the hedge fund’s activities, according to the creditors’ complaint. In that role, Goldman was the custodian of Bayou’s assets and a lender to the fund. Goldman also prepared Bayou’s account statements, the creditors said.
The award represents the amount of money that was put into the Bayou funds held at Goldman between March 2003 and June 2005. It accounts for just over 8 percent of the $250 million in losses that Bayou investors incurred in the fraud. If this award is included in the total recovered by Bayou investors, it will rise to more than half of their losses.
Bayou began losing money long before it went bust, for more than $88 million in losses during its association with Goldman. At the same time, Bayou told prospective investors that it had positive returns. During those years, Bayou marketed its relationship with Goldman as a mark of legitimacy, the creditors said.
Goldman was aware that Bayou was losing money, the creditors said. In 2004, Goldman’s risk managers created a list of the top 10 money losers among its clients. The No. 1 loser was a Bayou fund, and two other Bayou funds were ranker lower. The list, the complaint said, was circulated among Goldman executives.
A month after that list was circulated, Goldman requested and received a copy of Bayou’s marketing materials, which falsely claimed positive returns. Goldman also was warned about Bayou by an outside firm in 2002, the complaint said.
Goldman’s employees, the complaint said, “have repeatedly claimed that they had no obligation to concern themselves with what had occurred at the Bayou Hedge Fund at anytime.”

Below is the Wall Street Journal piece regarding Bayou v. Goldman Sachs.

JUNE 26, 2010
Goldman Told to Pay Bayou Fund Creditors
By SUSANNE CRAIG
Goldman Sachs Group Inc. was ordered to pay $20.6 million, the largest arbitration award levied against the securities firm, to unsecured creditors of Bayou Group LLC who accused Goldman of ignoring signs of fraud at the hedge-fund firm.
Bayou collapsed in 2005, and the firm's former chief executive, Samuel Israel III, is serving a 20-year prison term for fraud. He pleaded guilty to misrepresenting the value of Bayou's funds and defrauding clients out of more than $400 million.
Goldman cleared trades for the Connecticut hedge-fund firm before it collapsed. In 2008, Bayou's unsecured creditors' committee filed an arbitration claim against two Goldman units.
"Through either gross negligence or a willful choice to ignore the signs of fraud, [Goldman] failed to diligently investigate the red flags it was made aware of, to contact Bayou's auditors to request additional information, or to alert the appropriate authorities of what it had learned," lawyers for the committee alleged in the claim.
A three-person Financial Industry Regulatory Authority arbitration panel didn't provide an explanation for its ruling, issued Thursday. A Goldman spokesman said the panel didn't conclude that the firm committed any wrongdoing or violated any rules.
In its response to the initial arbitration filing, Goldman said the $20.5 million represents money that was fraudulently transferred among Bayou accounts and was never in Goldman's possession. Clearing operations typically maintain client records and send out trade confirmations, often earning big fees in return.
The Goldman spokesman said the New York company is "disappointed with the award and is exploring its options." Unlike court decisions, it is extremely hard to overturn arbitration awards because courts can't review the facts in an arbitration case. Courts are allowed to reverse such awards only for exceptional reasons, such as finding that an arbitrator acted improperly.
"This is a big victory for the victims," said Ross Intelisano, a partner at New York law firm Rich & Intelisano LLP who represented the Bayou creditors.
The largest previous arbitration award against Goldman was $2.8 million in 1994, according to Securities Arbitration Commentator, a Maplewood, N.J., newsletter that tracks arbitration cases. The Bayou ruling also is the sixth-largest arbitration award to any customer of a Wall Street firm, the newsletter said.
Winning damages from clearing firms is especially difficult because firms are required to spell out their duties in advance, often limiting their liability to only those functions. In its response to the arbitration filing, Goldman said the law "does not require clearing firms or prime brokers to monitor the suitability of the transactions they process or to investigate their account holders." Imposing such a standard "would slow commerce, raise costs and imperil financial markets," the firm said.
Separately, the Financial Crisis Inquiry Commission said Goldman President and Chief Operating Officer Gary D. Cohn and Chief Financial Officer David Viniar will testify at a hearing next week to examine the role of derivatives in the financial crisis.

Rich & Intelisano, LLP won a $20.5 million arbitration award against Goldman Sachs related to the Bayou hedge fund Ponzi scheme. The award is 100% of the compensatory damages requested. It is the largest arbitration award ever rendered against Goldman and the sixth largest customer arbitration award against any Wall Street firm. It is also the first win in any court or arbitration forum by investors against a clearing or prime broker related to a hedge fund Ponzi scheme based upon fraudulent transfer theories.

Partner John Rich masterminded the case, and tried it together with partner Ross Intelisano, with significant help from Matt Woodruff, Diane Mall Sammarco and Eric Clem of our office.

The award is on Finra’s website. The Firm represented the Bayou Creditors’ Committee in the 18 day arbitration hearing. The three arbitrator panel held over 13 pre-hearing sessions and 36 hearing sessions in 2008 through 2010.

From 1999 through 2005 Goldman Sachs Execution & Clearing, Goldman’s clearing broker, served as the sole prime and clearing broker for the Bayou funds. During 2002 through 2004, Goldman earned over $5 million in fees from Bayou. The Bayou victims alleged in their complaint that Goldman knew or should have known that Bayou was committing fraud and should have done an investigation into Bayou’s activities at Goldman. Instead, Goldman turned a blind eye to numerous red flags and suspicious activity in order to continue to reap fees.

The investment world is buzzing about the SEC’s fraud allegations against Goldman Sachs for misrepresenting and omitting to disclose Paulson’s role in choosing RMBS securities for the ABACUS CDO and then shorting the same individual RMBS through CDS transactions with Goldman. According to the SEC, “investors in the liabilities of ABACUS are alleged to have lost more than $1 billion.” It is hard to tell whether direct investors in ABACUS lost $1 billion or whether that includes companies which had CDS risk exposure to it. Either way, what are the money losers going to do about it?

According to the SEC complaint, IKB, the German commercial bank, bought $150 million of Class A-1 and Class A-2 Notes which seem to look like the AAA-rated upper tranches of ABACUS. But there is no other disclosure of who else bought ABACUS from Goldman. I presume that IKB was very cooperative with the SEC and allowed its name to be used in the complaint as opposed to being dubbed “Investor #1". IKB has likely been negotiating with Goldman behind the scenes. I expect to see a civil complaint filed by IKB against Goldman in federal court in New York shortly. However, they are probably better off arbitrating the dispute for numerous reasons (privacy, low cost, limited dispositive motion practice, etc.).

The SEC complaint also explains how a division of ACA, the monoline insurance company, served as the “Portfolio Selection Agent” for ABACUS, and another division of ACA (ACA Capital) also sold protection on $909 million of the super senior tranche of ABACUS through credit default swaps as well. ABN AMRO, the European bank, then assumed that same exposure through CDS deals with Goldman and ACA. The complaint alleges Goldman defrauded IKB, ACA and ABN AMRO. ABN AMRO was bought by the Royal Bank of Scotland and after ABACUS went to almost zero, RBS paid Goldman $841 million, most of which was then paid by Goldman to Paulson due to Paulson’s short bets on the underlying tranches. Got that?

So, RBS is holding the potential claims against Goldman (and Paulson?) for $841 million. Very interesting to see if RBS sues either of them.

But what about the rest of the ABACUS investors? According to the Flip Book available on Reuters’ website, ABACUS was a $2 billion synthetic CDO. Who else bought it besides IKB? And what are these investors going to do once they’ve read the SEC complaint? I have a guess or two.

By the way, Goldman netted $15-20 million for structuring and marketing ABACUS. Amazingly, Paulson paid Goldman $15 million to allow it to help pick the RMBS for ABACUS. This is a killer fact for the SEC.

Below is an article from Reuters this week regarding our client’s $3.4 million arbitration victory against Bear Stearns related to the Bear Stearns High Grade Fund. There are many investors who, for one reason or another, had decided not to file arbitrations against Bear Stearns. Investors should be aware that FINRA has a six year eligibility rule. In some jurisdictions, an investor who files a FINRA arbitration more than six years after the purchase of the High Grade Fund may be the subject to a motion to dismiss in the FINRA arbitration. Since the original High Grade Fund launched in about September 2003, early investors who are contemplating taking action should make a final decision sooner rather than later so as to avoid any potential motion. Investors who rolled over from the High Grade Fund to the Enhanced Leverage Fund should have no FINRA eligibility rule issues.

Investor in defunct Bear fund wins $3.4 mln award
3:15pm EST
* Award follows acquittal of fund managers
* JPMorgan Chase is responsible for paying the investor
By Matthew Goldstein
NEW YORK, Feb 9 (Reuters) - A Georgia-based chain of service stations that lost money with a Bear Stearns hedge fund that collapsed in July 2007 has won a $3.4 million arbitration award.
The award by the securities industry arbitration panel is the first ruling in favor of an investor in one of two now defunct Bear hedge funds since a jury acquitted the funds' former managers of criminal charges in November.
The award suggests that investors who lost $1.6 billion in the collapse of the two highly leveraged funds may still be able to recoup some of their money. The award was made on Dec. 23 and was posted recently on a website maintained by the Financial Industry Regulatory Authority.
The three-member arbitration panel, as is customary, did not offer much of a rationale in its written decision for the award of $3.4 million in damages to Racetrac Petroleum Inc, an Atlanta-based chain of more than 525 gas stations and convenience stores across the U.S. Southeast.
The award represents 70 percent of Racetrac's $5 million investment in one of the former Bear funds, according to a copy of the arbitration award posted on the website.
Ross Intelisano, one of Racetrac's attorneys, declined to comment on the award. Carl Bolch, chief executive officer of privately-held Racetrac, did not return a phone call.
The arbitration panel reached its decision after holding 32 hearing sessions last year. Six of those hearings took place in December, after a Brooklyn, N.Y., jury acquitted former Bear managers Ralph Cioffi and Matthew Tannin on Nov. 10.
Federal prosecutors had charged the pair with lying to investors about the health of the funds, which had invested heavily in complex bonds backed by subprime mortgages. The summer 2007 collapse of the funds, which at their peak controlled more than $30 billion in mortgage-related securities, is often seen as the start of the financial crisis.
The arbitrators found that Bear, which is now part of JPMorgan Chase & Co , was negligent and failed to adequately supervise the funds.
The Racetrac ruling shows that even though Cioffi and Tannin were acquitted, "they can still be held responsible in an arbitration forum for their misconduct," said attorney Steven Caruso, who represents Bear fund investors in a number of pending arbitrations.
The ruling is a blow to JPMorgan Chase, which assumed most of Bear's legal liabilities when it acquired the ailing investment bank in March 2008.
A JPMorgan spokesman declined to comment on the award.
When JPMorgan bought Bear for $10 a share in a deal engineered by the federal government, the bank said it was setting aside $6 billion to pay for any litigation arising from the acquisition. But following the acquittal of Cioffi and Tannin, some in the legal world thought investors in the Bear funds might have a tough time prevailing in lawsuits and arbitration.
Indeed, many investor lawsuits and arbitrations had been put on hold pending the outcome of the criminal trial.
But the Racetrac case went forward after a U.S. district judge rejected an attempt by federal prosecutors to stay the arbitration. (Reported by Matthew Goldstein; editing by John Wallace)

Below is a Reuter’s article about the first Bear Stearns High Grade Fund arbitration case won by an investor. John Rich and Ross Intelisano of Rich & Intelisano, LLP were lead trial counsel and Jake Zamansky and Ted Glenn of Zamansky & Associates were co-counsel.

"Investor in Defunct Bear Fund Wins $3.4 Mln Award"

* Award follows acquittal of fund managers

* JPMorgan Chase is responsible for paying the investor

By Matthew Goldstein

NEW YORK, Feb 9 (Reuters) - A Georgia-based chain of service stations that lost money with a Bear Stearns hedge fund that collapsed in July 2007 has won a $3.4 million arbitration award.

The award by the securities industry arbitration panel is the first ruling in favor of an investor in one of two now defunct Bear hedge funds since a jury acquitted the funds' former managers of criminal charges in November.

The award suggests that investors who lost $1.6 billion in the collapse of the two highly leveraged funds may still be able to recoup some of their money. The award was made on Dec. 23 and was posted recently on a website maintained by the Financial Industry Regulatory Authority.

The three-member arbitration panel, as is customary, did not offer much of a rationale in its written decision for the award of $3.4 million in damages to Racetrac Petroleum Inc, an Atlanta-based chain of more than 525 gas stations and convenience stores across the U.S. Southeast.

The award represents 70 percent of Racetrac's $5 million investment in one of the former Bear funds, according to a copy of the arbitration award posted on the website.

Ross Intelisano, one of Racetrac's attorneys, declined to comment on the award. Carl Bolch, chief executive officer of privately-held Racetrac, did not return a phone call.

The arbitration panel reached its decision after holding 32 hearing sessions last year. Six of those hearings took place in December, after a Brooklyn, N.Y., jury acquitted former Bear managers Ralph Cioffi and Matthew Tannin on Nov. 10.

Federal prosecutors had charged the pair with lying to investors about the health of the funds, which had invested heavily in complex bonds backed by subprime mortgages. The summer 2007 collapse of the funds, which at their peak controlled more than $30 billion in mortgage-related securities, is often seen as the start of the financial crisis.

The arbitrators found that Bear, which is now part of JPMorgan Chase & Co , was negligent and failed to adequately supervise the funds.

The Racetrac ruling shows that even though Cioffi and Tannin were acquitted, "they can still be held responsible in an arbitration forum for their misconduct," said attorney Steven Caruso, who represents Bear fund investors in a number of pending arbitrations.

The ruling is a blow to JPMorgan Chase, which assumed most of Bear's legal liabilities when it acquired the ailing investment bank in March 2008.

A JPMorgan spokesman declined to comment on the award.

When JPMorgan bought Bear for $10 a share in a deal engineered by the federal government, the bank said it was setting aside $6 billion to pay for any litigation arising from the acquisition. But following the acquittal of Cioffi and Tannin, some in the legal world thought investors in the Bear funds might have a tough time prevailing in lawsuits and arbitration.

Indeed, many investor lawsuits and arbitrations had been put on hold pending the outcome of the criminal trial.

But the Racetrac case went forward after a U.S. district judge rejected an attempt by federal prosecutors to stay the arbitration. (Reported by Matthew Goldstein; editing by John Wallace)

The SEC announced that it will continue to pursue its civil enforcement case against former Bear Stearns High Grade Fund portfolio managers Ralph Cioffi and Matthew Tannin, after the recent acquittal of criminal charges against Messrs. Cioffi and Tannin. According to recent news reports, Robert Khuzami, head of enforcement at the SEC, told Reuters TV, “We filed a case based on the evidence from our investigation.” Mr. Khuzami added, “we have a different standard of proof.”

The SEC’s complaint (available on its website) is indeed far more broad than the charges lodged by the U.S. Attorneys’ Office in Brooklyn. It also reaches all of the way back to the beginning of the High Grade Fund’s existence as opposed to just the late 2006, early 2007 time period the prosecutors focused on. The prosecutors’ standard of proof of “beyond a reasonable doubt” is much stiffer than the SEC’s and civil litigants’ standard of “by a preponderance of evidence.” In order for Messrs. Cioffi and Tannin to re-enter the securities industry, they will have to defend the SEC action as well.

Katherine Burton and David Glovin wrote a good piece on Galleon on Friday. Here it is.

Galleon Wiretaps Rattle Hedge Funds as Insider Trading Targeted

Oct. 26 (Bloomberg) -- First came the biggest bear market since the 1930s, then Bernard Madoff's $65 billion Ponzi scheme and the threat of increased regulation. Now hedge funds have a new concern: getting caught on tape as the government expands its use of wiretaps to ferret out insider trading.

Prosecutors, using secretly recorded phone conversations for the first time against hedge funds, alleged Oct. 16 that billionaire Raj Rajaratnam and five others made $20 million by swapping material inside information on companies such as Hilton Hotels Corp. and Google Inc. They may charge at least 10 more people soon, people familiar with the matter said last week.

Rajaratnam, founder of New York-based Galleon Group LLC, regularly talked to hundreds of contacts, including other traders, according to people who know him. His arrest rattled hedge-fund managers, who are questioning whether legitimate discussions caught on the tapped lines will draw scrutiny, say lawyers who've fielded such queries. A broader worry: whose phones are being monitored as prosecutors and U.S. Securities and Exchange Commission continue their probes?

"The word wiretap strikes fear in the hearts of everyone, even the innocent," said Brad Balter, who runs Balter Capital Management LLC, a Boston-based firm that allocates clients' money to hedge funds.

Ross Intelisano, an attorney with Rich & Intelisano LLP in New York, said he received a call from an executive at a $1 billion hedge fund who was considering hiring a company to test his firm's phones for listening devices. The client asked what to do if the firm found any. "Do we go to the police?" the executive asked, according to Intelisano.

The executive instructed his colleagues to be extra careful about what they say on the phone, not because they are breaking the law, but because they are fearful that any conversation about stocks could be misconstrued, Intelisano said.

Calls Aren't Safe

"After the Bear Stearns case, e-mails aren't safe, and now phone calls aren't safe," Intelisano said. "From now on, people are going to be meeting for lunch."

Prosecutors used e-mails to build their case against former Bear Stearns Cos. hedge-fund mangers Ralph Cioffi and Matthew Tannin, who are currently on trial in Brooklyn for misleading investors about the health of two funds that collapsed in 2007. It's the biggest trial stemming from a U.S. probe of banks and mortgage firms whose losses in subprime loans and related securities total at least $396 billion.

For hedge-fund managers whose knowledge of wiretaps may have been limited to "The Wire," the HBO drama in which Baltimore police eavesdrop on drug dealers, electronic bugging is a new reality of their industry as U.S. Attorney Preet Bharara's new Complex Frauds Unit targets white-collar crime.

Continue reading "Galleon Wiretaps Rattle Hedge Funds" »

Opening statements in the criminal trial of Ralph Cioffi and Matthew Tannin, the former portfolio managers for the Bear Stearns High Grade Funds, start today in federal court in Brooklyn, NY. The High Grade Funds imploded in 2007 causing $1.4 billion in investor losses. Prosecutors have charged Cioffi and Tannin with securities fraud and Cioffi with insider trading. The media coverage so far has focused almost exclusively on emails sent by Cioffi and Tannin regarding their personal thoughts about the Funds. The government alleges that Cioffi and Tannin thought the Funds were in serious trouble but then told investors on conference calls that everything was fine. While emails are often sexy and this is an important part of the case, the defense will likely argue that the email quotes were taken out of context and that the portfolio managers were simply analyzing the prospects of the Funds and were not intentionally lying to investors.

The press has not focused much on two just as important aspects of the prosecution’s case which should be easier to prove. First, according to the prosecutors, on the investor conference calls, the managers told investors that there was a lesser amount of investor redemptions in the High Grade Funds than there actually were. Here, the government can argue that Cioffi and Tannin clearly knew how much in redemptions were put in by investors yet they told investors a different number so investors wouldn’t run for the exits. The redemption amounts are undisputed facts and much less susceptible to defense spinning.

Second, the prosecutors allege that Cioffi and Tannin used their personal investments in the Funds as part of their pitch to investors, to invest in, and stay invested in the Funds. In early 2007, the government alleges Tannin told investors he was adding to his position. Also, Cioffi redeemed $2 million of his own personal monies in 2007 and did not notify investors. The government can argue that Tannin lied to investors about his own personal investments in order to keep them in the Funds. Also, that Cioffi, because he used his own personal investments in the Funds as a marketing tool, wilfully omitted his $2 million personal redemption in order to induce investors to stay in the Funds. The longer the Funds were alive, the better chance Cioffi and Tannin could continue to reap their multi million dollar annual bonuses.

Both of the these arguments are not as reliant on what Cioffi and Tannin believed when they wrote certain emails. Since it is unlikely that Cioffi and Tannin will testify at the criminal trial, the prosecutors may want to focus more on the redemption issues.

Matthew Tannin, the former Bear Stearns High Grade Fund portfolio manager, kept a personal diary of e-mails to himself in a G-Mail account. The U.S. Attorney's Office received the e-mails after using a search warrant on Google. According to e-mails released by prosecutors yesterday, Tannin wrote in as early as November 2006 that the funds "could blow up”. U.S. District Judge Frederic Block said at a hearing that he will likely allow prosecutors to introduce the newly obtained e-mails as evidence at Tannin’s trial. The U.S. Attorney's Office apparently has not finished reviewing all of the e-mails.

These e-mails could be extremely helpful in the government's case against Tannin. His trial is set for Oct. 13. The prosecutors can use Tannin’s e-mails to show his knowledge and intent that Tannin and a co-defendant Ralph Cioffi misled clients about the funds.

The e-mails may also be helpful for the many investors who have pending securities arbitration cases against Bear Stearns (our firm has multiple, significant arbitrations pending at FINRA). Since the notebook and Tablet PC of Cioffi and Tannin have gone missing, Tannin's newly discovered personal e-mail diary may be investors only chance to look into Tannin's thoughts regarding the funds.

The Bear Stearns High Grade Funds blew up in the early summer of 2007, precipitating the the credit crisis around the world. On October 13, 2009, in federal court in Brooklyn, NY, Ralph Cioffi and Matthew Tannin, the portfolio managers of the High Grade Funds, will be facing criminal trial on fraud and conspiracy charges. Cioffi has also been charged with insider trading. This is the first major criminal trial stemming from the subprime mortgage era. It will be closely watched around the world. The U.S. Attorneys' Office of the Eastern District of New York recently won a huge trial against former Credit Suisse broker Eric Butler who was convicted of fraudulently selling millions of dollars of auction rate securities. The Brooklyn jury convicted Butler of conspiracy to commit securities fraud, securities fraud and conspiracy to commit wire fraud and he faces a maximum sentence of 45 years in prison. A major battle is being fought over whether the prosecutors can introduce evidence that a Tablet PC and a notebook of Cioffi and Tannin disappeared and about Cioffi's lavish lifestyle.

Bear Stearns was ordered to pay at least $125 million by a New York bankruptcy judge for failing to disclose to investors that Manhattan Investment Fund was committing hedge fund fraud and the firm was instead accepting Manhattan’s funds to cover Bear’s margin exposure. This is a huge decision.

For many years, clearing firms and prime brokers have enjoyed significant protection from the courts when one of their clients have committed securities fraud. The firms have always argued: “all we were doing was clearing trades and providing margin.” The firms forgot to add “and minting money.”

Wall Street firms earn up to $10 billion in prime brokerage revenue each year. A big portion of this is from hedge funds. All the while, firms have been primarily shielded from potential liability when a fund blows up due to hedge fund fraud. The Manhattan decision may change that. Now, when a prime broker sees red flags of potential fraud by a hedge fund it does business with, it better start doing some due diligence.

With the U.S. government recently deciding not to regulate hedge funds, it looks like the major battles over who is to blame when hedge funds blow up will take place in courts and arbitration.