Philip Falcone, the founder of hedge fund Harbinger Capital Partners LLC, was sued by the U.S. Securities and Exchange Commission, a move that could end his plan to run a Berkshire Hathaway Inc.-style holding company if the regulator wins the case.
Falcone misappropriated client assets, favored selected investors and manipulated bond prices, the SEC said in its lawsuit.
“Today’s charges read like the final exam in a graduate course in how to operate a hedge fund unlawfully,” Robert Khuzami, the SEC’s enforcement director in Washington, said in a statement. “Clients and market participants alike were victimized as Falcone unscrupulously used fund assets to pay his personal taxes, manipulated the market for certain bonds, favored some clients at the expense of others and violated trading rules intended to prohibit manipulative short sales.”
The SEC is seeking disgorgement of ill-gotten gains, unspecified financial penalties and a bar prohibiting Falcone, 49, from serving as an officer or director of any public company, according to a statement by the agency.
Lew Phelps, a spokesman for New York-based Harbinger, said he had no immediate comment. Matthew Dontzin, an attorney for Falcone, said this week that Falcone would contest an SEC lawsuit involving the allegations.
The SEC action is the second blow in less than two months for Falcone, a former Harvard hockey center who built a $26 billion hedge fund by 2008 with a successful bet against subprime mortgages. Having suffered $23 billion in losses and withdrawals from the peak, Falcone is now fighting to keep control of his empire. LightSquared Inc., Harbinger Capital’s biggest investment, filed for bankruptcy in May.
Falcone in 2009 took out a $113 million loan from his Special Situations fund to pay personal taxes. The loan was disclosed in the fund’s annual financial statement the following March. At the time he borrowed the money, clients were barred from pulling money from the fund. Falcone subsequently repaid the loan with interest.
That same year, with client capital locked up, Harbinger allowed Goldman Sachs Group Inc., which at the end of 2008 had $1 billion invested in two Harbinger funds, to redeem some money from the firm, said a person familiar with situation.
In April 2011, Harbinger told clients that the government was looking into whether it had engaged in market manipulation in its trading of the debt securities of an undisclosed company from 2006 to 2008. The company whose debt Harbinger traded was MAAX Holdings, a Canadian maker of bathroom fixtures, said the person.
“He’s in a very tough spot,” said Ronen Schwartzman, founder of Ten Capital Advisors LLC, a New York-based firm that advises clients on investing in hedge funds. “It’s going to be difficult for him to raise money from investors ever again.”
Falcone grew up in Chisholm, Minnesota, the youngest of nine children. His mother worked in a shirt factory, and his father never made more than $14,000 a year as a superintendent at a local utility. He headed east to Harvard University in 1980, and after graduation joined a professional hockey team in Malmo, Sweden, where he played until he was sidelined by a leg injury. He ended up on Wall Street in the mid-1980s, trading high-yield debt at Kidder, Peabody & Co. in New York.
In 2001, Harbert Management Corp., a Birmingham, Alabama- based money-management company, was looking for someone to start a fund to trade distressed debt and came across a PowerPoint presentation from Falcone. Harbert hired him to start what became Harbinger, giving him $25 million to get the fund going.
Separately, the SEC said today it settled with Harbert,which served as the managing members of two Harbinger- related entities. The SEC said that Harbert and two of its units, HMC-New York Inc., and HMC Investors LLC, failed to take appropriate steps to address Falcone’s trade in MAAX bonds. The company agreed to pay $1 million, without admitting or denying wrongdoing.
In 2006, he put on the trade that would make his name. Falcone bought credit-default swaps, contracts that rose in value as the price of interest-paying securities constructed from individual home mortgages lost value. When the housing market collapsed in 2007 and defaults soared, Falcone got rich.
With the proceeds of that wager he spent $49 million on a 27-room mansion near Central Park in Manhattan once owned by Penthouse publisher Bob Guccione. He and his wife Lisa became benefactors of New York’s High Line elevated park and the New York City Ballet. Lisa, who was raised in Spanish Harlem by a single mother on welfare, became a film producer and was often photographed in society pages in designer outfits.
After the successful housing wager, Falcone tied his fortune as hedge-fund manager, and about $3 billion of investor assets, to LightSquared, which accounted for about 40 percent of the firm’s main fund as of April. Most hedge-fund managers have shunned illiquid holdings since the 2008 financial crisis, when they were forced to block client redemptions to avoid a fire sale, and investors have complained about the level of concentration in Falcone’s funds.
LightSquared filed for bankruptcy after the Federal Communications Commission said it would withdraw preliminary approval to build out a nationwide high-speed wireless network because it interfered with GPS devices. Last week, an affiliate of the company filed court papers seeking to borrow as much as $30 million to keep operating while under court protection from bankruptcy.
In an interview in April, Falcone made it clear he wasn’t giving up. He said he was considering a legal fight against the government, which had previously granted him permission to start building out the network.
He also said he was seeking to move away from hedge funds and building a public holding company, much like Warren Buffett’s Berkshire Hathaway, that would be better suited for long-term investments.
To help secure more permanent capital for investments, Falcone’s funds in 2009 bought Zapata Corp., a onetime oil driller, and turned it into Harbinger Group, a holding company that can raise capital for long-term investments. Falcone plans to use Harbinger Group to finance investments in six industries, including consumer products, financial products and natural resources, according to a 2010 regulatory filing.
Harbinger Group last year agreed to buy Old Mutual U.S. Life Holdings Inc., a provider of fixed-annuity and life insurance, for $350 million. Harbinger Group also owns a majority stake in Spectrum Brands Holdings Inc., a Madison, Wisconsin-based maker of pet food and batteries.
The company said in May 2011 that it was raising $280 million from a group led by Fortress Investment Group LLC. Harbinger Group has a market capitalization of $971 million.
Falcone stopped investor withdrawals from his hedge fund for a second time in December, after the fund told investors it had received a Wells Notice from the SEC, an indication that the regulator was contemplating a lawsuit.
Falcone previously said he received an opinion letter from outside counsel over the $113 million loan.
“It’s highly uncommon for a manager or sponsor of the fund to borrow money from the fund,” said Ron Geffner, a partner at Sadis & Goldberg LLP in New York that represents hedge funds. It “is wrought with conflicts of interest.”
Falcone has said in the past that allegations of preferential treatment of some clients were “completely and utterly untrue.” Harbinger’s offering documents allow it to give certain investors different terms than other clients, according to a person who has seen the documents.
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