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Hedge fund growth also creating fraud

STAMFORD, Conn. — The Jewish Federation of Metropolitan Chicago prides itself on international philanthropy and how efficiently and effectively it spends money.

But these days the federation is fighting to recover more than $4 million invested in an offshore fund operated by Bayou Securities. Federal authorities say Bayou, a Stamford-based hedge fund, was a fraud.

The federation's attorney and leaders declined to comment on its lawsuit. Bayou executives, who have not been charged, did not return telephone calls seeking comment.

Bayou is the latest in what regulators say is a growing number of frauds involving hedge funds, which are largely unregulated and traditionally serve institutions and wealthy investors. Hedge funds profit by using unconventional techniques, such as short-selling, or betting on falling markets to make a profit during market downturns. Hedge funds typically are active traders and can use techniques off limits to mutual funds.

In the last five years, the Securities and Exchange Commission brought 51 cases charging hedge fund advisers with defrauding investors of more than $1 billion. According to the agency, there are now about 7,000 hedge funds managing $870 billion in assets, a 260 percent jump over five years ago.

"The growth in hedge funds has been accompanied by a substantial and troubling growth in the number of our hedge fund fraud enforcement cases," the SEC said in a report last year.

Regulators say they are particularly concerned about the fraud because of a growing exposure of smaller investors, pensioners and charitable organizations to hedge funds in recent years.

To attract smaller investors, some funds have offered lower minimum entry requirements. Ordinary investors also passively participate in them through their pension funds and 401(k) retirement plans, which are increasingly putting billions into hedge funds.

The SEC has mandated new oversight for hedge funds, saying the move could help identify fraud earlier in some cases and deter others. The new regulation will open the funds' books to SEC examiners starting in February and make them subject to accounting and disclosure requirements.

Those who oppose regulating hedge funds have long argued that sophisticated investors are well equipped to detect fraud. They say hedge funds have not been disproportionately involved in frauds and the government should focus its limited resources on mutual funds that serve far more investors of modest means. Hedge funds have much higher minimum investments than mutual funds.

"You're dealing with people who understand the risks involved in investing in hedge funds," said David Friedland, director of the Hedge Fund Association and president of a hedge fund in Florida.

But even sophisticated investors have fallen victim to hedge fund frauds.

In Greenwich, a wealthy Connecticut suburb where hedge funds have concentrated in recent years, a New York University student and his mother were indicted in June on charges they ran a $7.4 million hedge fund scam.

Prosecutors say Ayferafet Yalincak, 50, and her son, Hakan Yalincak, 21, created the illusion of wealth to persuade investors to sink millions of dollars into a sham hedge fund. Prosecutors say they spent investors' money on a Porsche and a $1.25 million donation to New York University, then used those trappings to lure more investors. A trial is scheduled for November.

Bayou investors who lost millions called the fund a massive fraud that operated like a classic Ponzi scheme. Lawsuits filed in New York and Connecticut claim that Bayou executives hid massive investment losses by raising new money to pay withdrawing investors and to pay themselves fees and commissions they had not earned.

Bayou executives sent false statements and newsletters to investors, consistently overstating the fund's value and performance, according to the lawsuits. Bayou also falsely claimed that it had an independent auditor, one lawsuit alleges.

Stamford police say one of the investors recently found a suicide note written by Daniel Marino, Bayou's chief financial officer, alluding to fraud at the company. Marino was briefly hospitalized but has since been released.

Some Bayou investors lost retirement money, said Ross Intelisano, an attorney who represents nine Bayou investors.

"For some, it's a significant amount of their net worth," Intelisano said.

In Connecticut, home to a large number of hedge funds, state officials are planning to create a task force to recommend reforms to crack down on conflicts of interest and ensure funds have independent audits.

That move has some in the industry worried that more regulations are on the way, possibly jeopardizing the flexibility of hedge funds to respond rapidly to changing market conditions.

The Managed Funds Association, a group for hedge fund managers that claims about 1,000 members, favors an alternative approach of raising the net worth entry requirement to invest in hedge funds, said president John Gaine.

"We will be very vigilant in ensuring no unnecessary or unjustified regulations are put in place," he said.