Over the past few years, the U.S. Federal Bureau of Investigation (“FBI”) has become increasingly involved in policing hedge fund fraud. Traditionally, thought of by most as focusing on more criminal activities such as terrorism and bank robbery, the FBI has seen itself become more involved with other US regulators, such as the U.S. Securities and Exchange Commission, to investigate financial crime.
Perhaps this is because hedge fund fraud schemes appear to have gotten more intricate and complicated over the years. Or it could be that the under resourced financial regulatory agencies are increasingly looking to other government agencies such as the FBI for assistance. Another reason for increased FBI involvement may be because the types of activity involved in such frauds are increasingly viewed as more criminal in nature than simply lower level financial crimes . Finally, the increasingly large sums of money involved in such frauds may have something to do with it as well.
The FBI has not been shy about promoting its role in policing insider trading cases in particular. They even hired actor Michael Douglas to make a public service announcement encouraging people in the industry to report insider trading:
In addition to policing well known international hedge fund fraud such as the German based K1 fund of hedge funds scam, and going after informants in insider trading cases such as the Steven Fortuna in the Galleon case, the FBI is also focused on domestic hedge fund fraud. A recent example of such a hedge fund Ponzi scheme that the FBI was involved in, was the indictment of four North Carolina based hedge fund managers. These managers, including an individual named, John Davey, were accused of running a Ponzi scheme. Mr. Davey, it is alleged, from October 2007 through April 2010 ran a hedge fund Ponzi scheme called Black Diamond Capital Solutions.
While the exact facts of the case are not clear, the FBI alleged that Mr. Davey told investors that he had performed due diligence on a hedge fund named Black Diamond and that it was a low risk hedge fund. The problem was that the entire operations was a big Ponzi scheme and it is questionable whether there was even a Black Diamond fund to perform due diligence on. At trial, the government showed that by the end of the scheme, Davey and other hedge fund managers involved had less than $1 million total in their accounts, while maintaining a website for victims that reflected they had over $120 million in supposed values.
All told, Davey was alleged to have stolen over $40 million from over 400 investors. Mr. Davey funneled the money he stole into an offshore shell company in Belize. He used the money to build a mansion for himself in Ohio. Apparently the jury agreed with the FBI because after only 45 minutes of deliberation Davey was convicted on all counts.
In a related matter one of Mr. Davey’s alleged co-conspirators, Keith Simmons, was convicted in 2012 of securities fraud, wire fraud, and money laundering. He was later sentenced to 50 years in prison. The bank of Mr. Simmons, CommunityONE Bank, N.A., is also in trouble because the FBI alleges that they failed to maintain effective anti-money laundering program which therefore, allegedly effectively supported the work of the Ponzi scheme.
Investors should be increasingly aware of the criminal classification of potential hedge fund wrongdoing. As the recent insider trading prosecutions have shown, even well intentioned hedge funds who may not be running outright Ponzi schemes may find themselves on the wrong side of the law due to what may have previously been classified as technical violations that could have been satisfied with regulatory settlements. By performing detailed initial and ongoing operational due diligence, investors can take a step in the right direction towards avoiding funds that may receive an unwelcome visit from the FBI.