John C. Natale's name will forever be linked with hedge fund fraud. But in an ironic twist, Mr. Natale's name also is mentioned when it comes to hedge fund security.
Mr. Natale, 46, of Long Branch, N.J., pleaded guilty in March 2000 to defrauding investors in his Red Bank, N.J.-based Cambridge Partners LP and Cambridge Partners II LP hedge funds of more than $40 million over eight years.
However, he had a third, smaller hedge fund, which had less than $10 million in institutional fund-of-funds and wealthy individuals' money in it. Although Mr. Natale tried to transfer assets in that hedge fund to cover his losses in the two larger funds, a legal agreement he signed when he listed the smaller hedge fund on PlusFunds.com Ltd. prevented him from transferring money out of the PlusFunds account.
But the success Mr. Natale had siphoning off money from his hedge funds points to weaknesses in hedge fund monitoring, said Christopher C. Sugrue, chairman of PlusFunds Ltd., which runs the website. He said platforms such as PlusFunds, which list the net asset values and provide real-time risk reporting for various hedge funds, are one way investors can protect themselves.
But of the thousands of hedge funds in existence, PlusFunds lists only 20, with a combined value of about $500 million, Mr. Sugrue said. It's really up to investors to protect themselves.
"In an industry with very low barriers to participation, and now 5,000 people providing product, a certain number of those will be frauds," Mr. Sugrue said. "The hedge fund business, in my opinion, has outgrown the structures that were initially sufficient to help it run and organize itself efficiently."
In all, high-profile hedge fund fraud cost investors close to $1 billion in 2000, according to published reports.
A number of pension funds, including the California Public Employees' Retirement System, Sacramento; BellSouth Corp., Atlanta; the State Board of Administration of Florida, Tallahassee; and the Oklahoma Firefighters' Pension & Retirement System, Oklahoma City, all are either considering hedge fund investments or have hired hedge fund managers.
And when they look at hedge funds, they and other institutional investors might do well to keep Mr. Natale's story in mind.
Between 1992, when he started the funds, and 1999, Mr. Natale gathered close to 180 investors in his Cambridge Partners and Cambridge Partners II hedge funds. His investment philosophy was to short Internet and technology stocks, believing the bull market would soon end. As stock prices fell, he reasoned, his fund - and its investors - would make big gains.
But Internet and tech stocks continued to skyrocket, and Mr. Natale's investors instead lost huge sums of money - $20,000 within months of starting the funds, according to charges filed against Mr. Natale in New Jersey Superior Court in Newark.
Rather than let on to his investors, Mr. Natale admitted in court to using a Ponzi scheme to cover his tracks. He used new capital to cash out investors who left the funds and created false audits, tax documents and monthly statements to investors.
Meanwhile, the hedge fund Mr. Natale had set up on the PlusFunds platform, which hedged large-cap domestic stocks and avoided tech stocks, was performing well. Aware of the success of the PlusFunds hedge fund, Mr. Natale tried taking money from that account and moving it to Spear, Leeds & Kellogg, New York, the prime broker overseeing the Cambridge hedge funds, to cover his larger losses in those funds, Mr. Sugrue said.
For the PlusFunds hedge fund, Mr. Natale used the Bear Stearns Cos. Inc., New York, as prime broker.
Hedge funds listed on the PlusFunds platform, are separate but parallel funds, Mr. Sugrue said. Everything can be the same as in the original hedge fund, but the manager agrees not to commingle the outside hedge fund money with the money in the PlusFunds fund. Also, any assets moved out of the PlusFunds hedge fund, except for client redemptions, must be put into a new PlusFunds account - barring Mr. Natale from accessing the PlusFunds hedge fund assets, Mr. Sugrue said.
Finally, in mid-February 2000, after eight years of hiding losses, Mr. Natale broke down and turned himself in to the New Jersey Attorney General's office. On March 3, 2000, he pleaded guilty to securities fraud, theft by deception and misapplication of entrusted property. On Feb. 16 of this year, New Jersey Superior Court Judge Joseph Falcone sentenced Mr. Natale to 10 years in prison, barred him from working in the securities industry ever again and ordered him to pay $51 million in restitution. Mr. Natale is broke, however, so investors are unlikely to get their money back, said Emily J. Hornaday, spokeswoman for the New Jersey Division of Criminal Justice.
Fraud like that perpetrated by Mr. Natale and others is on the rise because more money is going into hedge funds and because hedge funds aren't closely regulated, said Thomas Fedorek, a managing director at the New York investigative firm Kroll Associates, which conducts due diligence for financial services firms, business intelligence, investigations and security.