Bayou Hedge Fund Fraud Case

How it Happened?
In 1995, Sam Israel III and James Marquez launched the Bayou Group LLC, with
initially good intentions to produce high returns for investors. With $300 million
of initial funds in the Bayou Hedge Fund Group, Israel, along with CFO Daniel
Marino, promised investors that the fund would be worth $7.1 billion in ten
years. However, the fund almost immediately started experiencing losses,
prompting Israel to start defrauding early on in the game. What resulted was a
faade that lasted nearly a decade, where oblivious investors would keep pouring
money into Bayou, with the false notion and supporting documentation that the
fund was achieving monumental gains.

In 1998, trading losses started to accumulate. It was clear that the Bayou
strategy was not garnering the kind of returns that Israel had promised his
investors. Instead of altering the strategy or closing up shop, Israel opted for
another alternative. He started a fake corporation to audit Bayou, and produced
false documentation overstating gains, understating losses and positioning
Bayou in a light that actually made it look successful. In reality, the fund never
made any money. Israel would consistently send out performance reports to
investors and at one point claimed the fund was worth $450 million.

But Israel wasnt necessarily losing money. He funneled all

of the hedge funds trades through Bayou Securities, reaping
huge commissions since hedge funds trade millions of
dollars of stocks every day. So even as the hedge fund lost
money, Israel still banked through his securities firm.

While investors were pleased with the faade of a brilliant

investment, Israel and Marino were living the high life. Israel
settled into a mansion just north of New York City that he
rented from Donald Trump for $32,000 a month while
Marino was parading around the east coast in his new
Bentley.

In 2004, Israel started to panic and was desperate to make back what he lost in
the fund. He suspended the funds trading activities and wired $150 million to a
bank account overseas and proceeded to launch a prime bank instrument
fraud. Basically, in this type of fraud, investors are promised above average
returns, (in this case, 100% a week), since the manager supposedly has access
to a secret trading platform. Of course, this is never the case as there is no
secret trading platform in existence.

In July 2004, officials were alerted when an abnormally large transfer of $99
million was made into a Wachovia account in New Jersey, prompting the initial
investigation and the ensuing demise of Bayou.

What was amazing about Bayou was how Israel managed to dupe investors into
giving him such a substantial amount of money. One of the biggest obstacles
new hedge funds face is securing initial capital. Israel not only did that, he did it
to the tune of $300 million. He even got well established fund of funds to invest
in Bayou, establishments that are adamant on conducting extensive background
checks. Israel had the charm, contacts and Wall Street background to gain the
trust of very affluent individuals. In retrospect, investors wish they had noticed
some of the red flags accompanying Israel. For one, the fake accounting
firm. With large hedge funds, there is almost always an established, big-name
accounting firm used, which was not the case here. Also, Israel never charged a
management fee, an action almost unheard of with hedge funds. He also gave no
resistance to investors who wished to pull out, another tactic not usual in the
hedge fund industry.

In April of this year, Israel was sentenced to 20 years in prison after pleading
guilty to fraud. He was also ordered to pay $300 million back to investors.

On June 10th, 2008, the same day he was supposed to start his 20-year sentence,
Israels SUV was found abandoned on the banks of the Hudson River, with the
words Suicide is Painless scrawled through the dust of the window. However,
officials were reluctant to confirm his suicide for several reasons. For one, no
body turned up. The Bear Mountain Bridge, where Israel supposedly plunged to
his death, has been used by others as a sure-fire suicide method. However, those
bodies have turned up on the banks of the Hudson, usually only days after the
jump.
Several weeks later, on July 2, Israel surrendered to federal law enforcement
authorities. He was given two additional years of prison time for faking his own
death, and is currently serving a 22 year sentence.

James Marquez is serving his 4 year sentence for his role in the crime, which
was determined to be around $6 million.

Causes
This case is possibly happened because of Israel and Marino inability to pay up
investors due to mounting losses that the company experienced early in the
business. But, instead of coming clean to the investors by closing the business or
altering their business strategy, they opted to start another fake audit operation
which lasted for several years. Until now, the investors still hasnt sure whether
Israel is a good crook or is he really cared with the investors, this happened
because many investors were taken by good guy Israel that oozed charm and
charisma that makes people captivate and interested to invest in their company.
Other reasons why fraud happened are greed, lack of transparency, poor
management information, non-independent audit department, poor accounting
control, and complacency. We can see from this case that it has all the signs and
potential of fraud, but due to complacency by investors and the controlling body
itself, the fraud could last for a decade.

Consequences
The direct consequences of this case are the decrease of investors trust in hedge
fund practices across US. SEC also seeking permanent injunctions for violations
of the antifraud provisions of the federal law against Israel. The SEC also seeks to
hold the defendants accountable for their actions, while recovering the assets of
harmed investors. Due to this case, the SEC also planned to outsource the SEC
fraud audits to third parties that specialized in forensic accounting and have the
experience in uncovering fraud, since fraud detection is difficult.
For investors who became the victim of the fraud, it taught them several
importance lessons in investing their money, such as the importance in being
diligent, the ability to connect the dots, see the yellow and red flag of
misconduct, and the courage to call the SEC to investigate the firm if the
investors see several anomalies in the investment company.

Suggestions
The lessons that we learned from this case is the importance of caution and
scepticism in investing our money. Thus, before investing in any investment
product investors needs to do their homework and do their research to make
sure that the investment is legit and wont turns out to be a big lie. Another
suggestion is to provide more human power to the authority to respond to tip-
offs of fraud and/or outsourcing the fraud investigations to third parties.

References
The Bayou Hedge Fund, Sam Israel and the $450 Million Faade. Hedge Fund
Articles. N.p., 16 June 2008. Web. 08 Feb. 2017.
<http://www.hedgeco.net/hedgeducation/hedge-fund-articles/the-bayhou-hedge-
fund-sam-israel-and-the-450-million-facade/>.
The Bayou Story. The Importance of Being Diligent. Star Magnolia Capital, 22
Nov. 2013. Web. 08 Feb. 2017. <http://www.being-diligent.com/the-bayou-
story/>.
Cantrell, Amanda. How Some Big Investors Got Duped by Bayou. CNNMoney.
Cable News Network, 29 Sept. 2005. Web. 08 Feb. 2017.
<http://money.cnn.com/2005/09/29/markets/bayou_investors/index.htm?
section=money_latest>.
"SEC CHARGES SAMUEL ISRAEL III, DANIEL E. MARINO, BAYOU MANAGEMENT,
AND BAYOU FUNDS FOR DEFRAUDING HEDGE FUND INVESTORS AND
MISAPPROPRIATING INVESTOR ASSETS." SEC Charges Samuel Israel III, Daniel E.
Marino, Bayou Management, and Bayou Funds For Defrauding Hedge Fund
Investors and Misappropriating Investor Assets. U.S. Securities and Exchange
Commission, 29 Sept. 2005. Web. 08 Feb. 2017.
<https://www.sec.gov/news/press/2005-139.htm>.
Hansard, Sara. "Hennessee Charged in Bayou Hedge Fund
Case." InvestmentNews. Crain Communications Inc., 23 Apr. 2009. Web. 08 Feb.
2017.
<http://www.investmentnews.com/article/20090423/REG/904239991/hennessee-
charged-in-bayou-hedge-fund-case>.
Frost, Ken. "Top 10 Reasons Why Frauds Occur." Metro. N.p., 14 Sept. 2012. Web.
08 Feb. 2017. <http://metro.co.uk/2012/09/14/top-10-reasons-frauds-occur-
3817555/>.