In 2005, the SEC filed a civil action suit against Samuel Israel III and Daniel E. Marino, managers of a group of hedge funds known as the Bayou Funds. The SEC alleged that Israel and Marino defrauded millions of dollars in investor funds for their personal use. In addition to the civil suit, criminal fraud charges against Israel and Marino were also made.
The SEC’s complaint alleged that from 1996 through 2005, investors deposited more than $450 million into the Bayou Funds. During that time period, Israel and Marino defrauded current investors and attracted new investors by grossly exaggerating the Bayou Funds’ performance to make it appear that the funds were profitable and attractive investments. In actuality, the funds had never posted a profit.
In addition, Israel and Marino fabricated and distributed periodic account statements and performance summaries to the funds’ investors containing fictitious profit and loss figures. They also forged audited financial statements in order to hide millions of dollars of trading losses from investors.
In its complaint, the SEC also alleged the following:
• In 2003, the Bayou Funds’ performance was overstated, claiming a $43 million profit in the four hedge funds, while trading records show that the Bayou Funds actually lost $49 million.
• In 1999, Marino created a sham accounting firm, “Richmond-Fairfield Associates,” that he used to fabricate annual “independent” audits of the Bayou Funds. This sham firm attested to the fake results that he and Israel had assigned to the Bayou Funds.
• Israel and Marino stole investor funds by annually withdrawing “incentive fees” from the Bayou Funds that they were not entitled to receive because the Bayou Funds were never profitable.
• By mid-2004, Israel and Marino suspended trading securities on behalf of the Funds and transferred all remaining assets (about $150 million) to non-Bayou-related entities for investment in fraudulent prime bank note trading programs and venture capital investments in nonpublic startup companies.
• Bayou management continued to send to investors periodic account statements and financial statements that falsely showed profitable hedge trading activities through mid-2005 despite having abandoned their hedge trading in 2004.
(www.sec.gov/news/press/2005-139.htm.)
Despite the fact that the Bayou Funds fraud consisted of many red flags, many people invested large amounts of money in the funds. What are a few ways that these investors could have prevented their monetary loss?