By Justin Hibbard A week after executives of Stamford (Conn.)-based hedge fund Bayou Management pleaded guilty to fraud charges, another hedge-fund scandal is brewing on the opposite coast.
Lehman Brothers (LEH) filed a suit on Oct. 3 in California Superior Court in San Francisco against hedge-fund firm Wood River Capital Management, which is based in San Francisco and Ketchum, Idaho, and claims to manage $500 million. The suit alleges that Wood River lured Lehman into a fraudulent stock-transfer scheme in September, resulting in the investment bank wiring $20 million into Wood River's Merrill Lynch account. Since then, the suit claims, Wood River and its principal, John H. Whittier, have allegedly obtained, or tried to obtain, the money.
FRETTING INVESTORS. Lehman has been unable to contact Wood River since Sept. 28 and believes the firm ceased operations that same week. A five-year lease on Wood River's downtown San Francisco office expired Sept. 30, according to a lease agreement dated June 6, 2000.
Reuters reported on Oct. 5 that Wood River has been incommunicado recently and that investors in its three-year-old fund were growing concerned. Calls placed by BusinessWeek to Wood River's San Francisco office on Oct. 6 reached a general voice-mail box that did not accept messages, and calls to Whittier's direct line reached a voice-mail box that was full. A voice-mail message left for Whittier at Wood River's Ketchum office was not returned by press time. Lehman's outside counsel, Jones Day in San Francisco, referred a call to a Lehman spokesperson, who said the firm doesn't comment on pending litigation.
Among the investors in Wood River's fund is Albuquerque (N.M.)-based energy utility PNM Resources (PNM). PNM spokesman Don Brown says it's PNM's policy not to comment on its investments (see BW Online, 9/2/05, "Keep a Wary Eye on That Hedge Fund").
TRANSACTION SETUP. Court records show that in June, 2000, Whittier, former co-head of media and communications equity research at investment bank Donaldson, Lufkin & Jenrette, signed a five-year lease on Wood River's 4,442-square-foot office in downtown San Francisco, at a base rent of $31,464 a month. Three months later, the landlord, The State Teachers Retirement Board of Ohio, sued Whittier and Wood River alleging failure of rent and fees totaling $67,885. The case was dismissed without prejudice in September, 2002.
Whittier first approached Lehman in June, 2005, according to Lehman's suit. The investment bank performed brokerage services for Wood River and Whittier in July. Two months later, Whittier asked Lehman to finance a transfer of 800,000 shares of Endwave (ENWV), a Sunnyvale (Calif.)-based maker of radio-frequency components used in cell-phone networks and defense systems, the suit says.
Lehman was to use its funds to buy the shares through Wood River's account at Merrill Lynch. Then, Wood River would buy the shares from Lehman through Wood River's account at Wedbush Morgan Securities, thereby reimbursing Lehman. In addition, Wood River would pay Lehman a fee.
On Sept. 22, Lehman arranged to purchase the Endwave shares at $26 each, or $20.8 million. It had until Sept. 27 to pay Merrill Lynch. But when Lehman tried to prepare for the subsequent sale to the Wedbush account, it discovered that Wood River had not arranged for the transfer to Wedbush, according to the suit.
STOCK NOSEDIVE. When Lehman contacted Wood River, its employees allegedly assured Lehman they would make the arrangements. On Sept. 28, Lehman bought the shares through Merrill Lynch. Since then, it has been unable to confirm whether Wood River has an account at Wedbush, and it has been unable to contact Whittier or Wood River.
Lehman was left holding 800,000 shares of Endwave. From Sept. 27 to Sept. 30, Endwave's share price plunged from $27 to $13, wiping out $158 million in market value. Lehman began selling off its shares on Sept. 29. Trading volume in Endwave stock that day reached 8.14 million shares -- 325 times the three-month average.
Endwave issued a statement that day: "Management is not aware of any developments related to the company that would account for recent weakness in the company's share price and increased market activity." Endwave assured investors that it would go ahead with a planned secondary stock offering, for which it had filed a registration statement on Sept. 15. Short interest in Endwave stock rose 2.7% in September, to 2.3 million shares, or 20% of shares outstanding.
APPEARANCE ORDERED. Lehman is seeking damages that it says it expects to be no less than $8 million. On Wednesday, a San Francisco Superior Court judge issued a temporary restraining order against Whittier and Wood River that forbids them from obtaining proceeds from Lehman's Sept. 22 stock purchase. The judge ordered Whittier to appear before the court on Oct. 27.
A spokeswoman for the California Attorney General's office says the office is not aware of the Lehman suit. She says Wood River is not being investigated by the office.
With Roben Farzad in New York
Hibbard is a correspondent in BusinessWeek's Silicon Valley bureau