Toomre Capital Markets LLC

On May 28^th 2008, The New York Times is reporting (via Reuters) that Liquidators Of Bear Stearns Funds Lose Court Appeal. Apparently the representatives of the two collapsed Bear Stearns Cos Inc hedge funds -- the High-Grade Structured Credit Strategies Fund and the High-Grade Structured Credit Strategies Enhanced Leverage Fund -- linked to risky mortgage investments have lost a court appeal seeking to have the funds liquidated in the Cayman Islands instead of in the United States.

The ruling by U.S. District Judge Robert Sweet in Manhattan upholds a bankruptcy court's decision last year requiring that the funds be liquidated in U.S. courts. Holding the proceedings in the Cayman Islands, home to many hedge funds for tax reasons, could have shielded the funds' assets from some U.S. creditors. The ruling could have implications for other funds that seek protection under Chapter 15 of the U.S. Bankruptcy Code, which covers cross-border insolvencies. The judge upheld the bankruptcy court's finding that the funds' "center of main interests," as defined by Chapter 15, was in the United States.

"It is hoped that resolution of these issues may provide some aid to navigation in these uncharted waters," Sweet wrote in the decision, dated May 22 and made public on Tuesday.

"The process by which the financial problems of insolvent hedge funds are resolved appears to be of transcendent importance to the investment community and perhaps even to the society at large."

Toomre Capital Markets LLC ("TCM") has previously written about the hedge fund con artist Kirk S. Wright and his now-defunct Atlanta-based hedge fund management firm International Management Associates. (Interested readers might want to review the TCM posts entitled Update on Kirk Wright and IMA hedge fund fraud scandal or Kirk Wright, IMA Hedge Fund Manager, Arrested in Miami Beach.)

According to The International Herald Tribune, on Wednesday May 21^st 2008, this con artist was convicted in Atlanta Federal court of many fraud counts that effectively would lead to spending the rest of his life in Federal prison upon sentencing. From the article,

According to authorities, Wright and his company collected more than $150 million spread across thousands of client accounts since 1997 and used false statements and documents to mislead some of them to believe the value of those investments was increasing. Much of that money is missing.

Prosecutors said Wright had been lying to his investors since at least 2001 about their investments' performance and the balances in their accounts. He reported substantial investment gains almost every month; the evidence revealed that he lost almost every dollar invested in the market, prosecutors said.

They said he diverted millions of dollars of investor's money for personal expenses, including cash for himself and family members, jewelry, house renovations, a $500,000 wedding, up to six luxury vehicles, and multiple pieces of real estate, mainly in Atlanta and California….

According to the U.S. Attorney's Office in Atlanta, Wright could receive a maximum sentence of 710 years in prison, a fine of up to $16 million and be ordered to pay restitution to the victims. He already has been hit with a $20 million judgment as part of a civil suit filed by the Securities and Exchange Commission. Sentencing is set for Aug. 26.

Toomre Capital Markets LLC ("TCM") has watched the deleveraging of the financial system progress through one after another area of the Capital Markets. First it was the sub-prime mortgage sector and the intense focus on where the ABX was trading down to. Then, there was an awe-like focus on Collateralized Debt Obligations ("CDOs"), Asset-Backed Commercial Paper ("ABCP") and Structured Investment Vehicles ("SIV"). Next focus shifted to whether the monoline credit insurers likeAmbac and MBIA might survive. More recently, leveraged loans, Alt-A mortgages and commercial mortgage-backed securities ("CMBS") have been sinking in value. Finally, in the last ten days, there was intense speculation about whether the investment banks and primary dealers might survive, culminating the virtual bankruptcy of Bear Stearns last weekend.

This week the earnings reports from Goldman Sachs, Lehman Brothers and Morgan Stanley all exceeded the much diminished analyst expectations for their first quarter earnings reports. What was relatively impressive is that diversified trading operations produced sufficient revenues to offset asset write-downs of between $1.5 and $2.5 billion. As a result, the pressure on the investment banks (for the moment at least) seems to have eased. The question now is in what sector of the capital markets will the next stage of the credit crisis appear? Will it be with the three wounded ducks (Citigroup, Merrill Lynch and UBS), the European banks or the many hedge funds seemingly just barely hanging on?

Toomre Capital Markets LLC suspects that next focus will be on the hedge fund community. By way of example, consider what has happened with Endeavour Capital LLP and JWM Partners LLC this year. From the website www.egoli.com.au comes the news that:

Toomre Capital Markets LLC ("TCM") earlier in 2007 was quite worried about liquidity risk and the level of risk premiums that investors were assuming through their various investment strategies in the proverbial search of yield or return. Interested readers might perhaps want to reread the February 12th 2007 TCM post entitled Hedge Funds, Investment Banks and the Value of Liquidity? where we wrote:

Economic times presently are pretty good world-wide. When the inevitable turn in the vastly more inter-connected global economy next comes, credit spreads surely will widen and the valuation of various financial instruments will come under stress. Are hedge funds (and by proxy the investment banks) prepared for coming "Great Unwind" forecast by Mr. Stiamann and Knips? Some hedge funds inevitably will do very well then, while others will fail, perhaps as spectacularly as Amaranth Advisors did in September 2006.

The financial markets now are full of much liquidity. Are investors, speculators and their bankers appreciating and pricing in liquidity risk? Toomre Capital Markets LLC would suggest that liquidity risk presently is greatly under-valued in the search for "alpha", absolute return and portfolio yield. The stretch to get ten percent return (after fees) appears to be making rational people start to do irrational things.

Sadly, many institutional investors did not heed this warning about the then insane pricing of liquidity risk. Over the past week, Lars Toomre has had the chance to catch up some of his much neglected reading. Several stories in particular are noteworthy in the context of liquidity risk and the consequences of reaching for yield. Lars will try to complete write-ups in the next few days about several of these sad tales to remind future investors of the consequences of investing in something not well understood for the promise of that incremental return or enhanced yield.

As many readers of the Toomre Capital Markets LLC ("TCM") blog may already be aware, the next Hedge Fund Executive Forum Series event entitled Real-Time Decisions & Risk Reduction: Technologies that Reduce Latency and Sharpen Business Intelligence to Drive Results will be held in New York City on Thursday November 29th 2007 and then repeated in Stamford, CT on Tuesday December 4th. Lars Toomre will be one of the speakers at this event. Both Aldon Hynes and Lars Toomre hope that you will be able to join the Incremax and Toomre Capital Markets team at either of these venues.

These Hedge Fund Executive Forum Series events are designed to help key investment decision makers quickly get beyond buzz words and learn which strategic technologies and solutions will help drive the best results from every aspect of their organization -- the front, middle and back-offices as well as client service functions. Designed for investment managers with more than $500 million in assets under management ("AUM"), the focus of this particular event will be on data, input/output ("I/O") and how "push vs. pull" can be implemented.

The key challenge this forum event will address is how to create better real-time decision opportunities that result from first transforming fast-moving data into information and then into knowledge that ultimately adds to economic value. Some of the key solutions and technologies from Advent Software, AMD, Cisco, Microsoft, Reuters and Streambase Systems will be highlighted for further discussion.

Please circle the appropriate date on your calendar and plan on attending. Advanced registration is required and can be completed at this web link. Aldon Hynes and Lars Toomre look forward to speaking with you directly on the 29th or 4th. Hopefully, we will see you then. Please feel free to contact TCM directly if you have any questions or comments.