Another Fishy Hedge Fund


By Justin Hibbard and Adrienne Carter Ketchum, idaho, is the kind of place where people tend to know each other. Close to the Sun Valley ski resort, the tony town of 3,873 boasts several Wall Street refugees who manage money for wealthy neighbors and clients elsewhere. Yet few residents say they know John Whittier, a 39-year-old money manager who moved to the area about five years ago and opened an office for his fledgling hedge-fund firm, Wood River Capital Management, named for the picturesque river that runs through Ketchum.

Locals describe Whittier as an absent-minded-professor type who drives a Lincoln Navigator and sometimes fetches his morning coffee from a Tully's cafn his pajamas. Beyond that he keeps to himself, they say.

Investors in Wood River's funds apparently didn't know much about Whittier, either. The ex-stock analyst at investment bank Donaldson, Lufkin & Jenrette presented himself as a savvy stock trader overseeing hundreds of millions of dollars for investors. Marketing materials for his flagship fund trumpet 25% returns in the first eight months of this year, a period when the stock market was basically flat.

WARNING SIGNS. But some investors got nervous and tried -- unsuccessfully -- to get their money back late last month when Whittier's big bet on an obscure Silicon Valley stock slumped badly, say investors' lawyers. The firm stopped answering its phone. Last week, Wood River's offices in downtown Ketchum were locked and apparently unoccupied. FedEx packages piled up outside next to strollers and a red wagon left by Whittier's two young children.

Wood River is now the subject of a preliminary investigation by the Securities & Exchange Commission -- the latest hedge-fund scandal that is sure to intensify calls for greater government oversight of these lightly regulated investment pools. Only two weeks ago the founders of collapsed Bayou Management, a hedge fund in Stamford, Conn., pled guilty to criminal fraud.

As in the Bayou affair, Wood River presented red flags that careful investors should have noticed. The firms Wood River's promoters named as its outside auditor and bookkeeper, for example, say flatly that they didn't provide those services to the hedge fund. Morgan Stanley (MWD), listed in April as one of the hedge fund's two prime brokers, in fact was not, according to a person familiar with the matter.

A TIP FROM FRIENDS. The full picture of what unfolded at Wood River isn't yet in focus. Whittier and others at the firm remain incommunicado. An attorney for Wood River didn't return phone calls. But the case clearly illustrates the perils of a secretive sector of the investment industry flooded in recent years by institutions and wealthy individuals hungry for outsize returns.

Other potential danger signs included Whittier's self-proclaimed transformation from low-profile analyst to would-be investment seer. His purported stock-picking skills were promoted by a half-dozen other firms that specialize in luring investors to hedge funds.

A 69-year-old retired insurance executive in North Carolina says he invested $1 million with Wood River this year based on the recommendation of two friends who know Whittier. The investor, who asked not to be named, says everything he heard about the money manager made him sound "like the kind of guy you'd want for a brother or a son." Whittier graduated from the University of California at Berkeley in 1989 and has said that he worked for two years as a Republican political aide before moving to the financial world.

MORE TO COME? The first warning the North Carolina investor got came last month from the SEC, which asked him for all communications he received from Wood River. Since then he has been phoning, faxing, and e-mailing the hedge fund -- to no avail. Worried that he'll lose the entire $1 million, he says: "I'm pretty much finished with hedge funds."

Financial industry veterans fear Wood River won't be the last of its kind to fizzle. As hedge funds proliferate and competition increases, more are bound to fail, predicts Barry P. Barbash, a former director of the SEC's investment-management division. "They're going farther out on the risk curve," says Barbash, now a partner at law firm Shearman & Sterling.

Big Wall Street firms aren't immune to the allure of hedge funds. Lehman Brothers (LEH), which, like its rivals, has scrambled to win trading business from hedge funds, alleges that Wood River drew it into a fraudulent stock transfer in September. In a lawsuit filed in California state court in San Francisco, where Wood River also has an office, Lehman claims the fund tricked it into wiring nearly $21 million to a Wood River account at Merrill Lynch (MER). Then, the suit says, Whittier and Wood River tried to grab the money.

SCANT SCRUTINY. "Brokerage firms have become very dependent on hedge funds," says Barbash, the former SEC official. Without referring specifically to Lehman, he adds: "A lot of times what passes for due diligence is really unverified hearsay." Lehman declined to comment. In a statement, Merrill said it recently ended its relationship with Wood River after uncovering "irregularities" in certain transactions.

The ballooning of the hedge-fund business has brought more SEC enforcement, but the number of cases is still modest given the size of the industry. Over the past five years the number of hedge funds has doubled, to more than 8,000, and the assets they manage have likewise doubled, to $1 trillion, according to Hedge Fund Research in Chicago. During the same period, the number of SEC cases against hedge funds has risen from two in 2000 to 19 last year. There have been 15 so far in 2005.

A new SEC rule goes into effect in February that requires hedge-fund managers to register with the agency. But even advocates of regulation concede that mere registration won't do much to deter fraud, and skeptics in the industry warn that it could give some investors the false sense that they don't have to do their own homework. SEC Commissioner Paul Atkins, a Republican who opposed the new rule, said in a speech in New York last month that the agency has "neither the resources nor the expertise to oversee all of the potential new registrants."

PLUNGING STOCK. At least one reason Wood River ran into trouble was Whittier's risky decision to buy a huge stake in Endwave (ENWV), a small Silicon Valley maker of wireless-communications gear. Investors got wind of the investment in late September, says Ron S. Geffner, an attorney at Sadis & Goldberg who represents Wood River shareholders. "My clients are concerned, given the concentration of the fund's position in an individual security," he says.

Their concern was justified: Endwave shares were plunging. Since mid-July the stock price has declined 76%, to $13. Wood River's 39% stake in Endwave is now worth $56 million. In its lawsuit, Lehman says it was hired to help Wood River buy an additional 800,000 Endwave shares before the transaction went awry. Endwave CEO Edward A. Keible Jr. says he can't explain the stock's fall and didn't know about Wood River's big stake until the afternoon before the hedge fund disclosed it in an SEC filing on Oct. 7.

Another group of investors in an offshore fund Wood River runs learned in late September that members of the firm's management had abruptly quit, says Scott Berman, an attorney at Friedman Kaplan Seiler & Adelman who represents the investors. Berman says his clients tried unsuccessfully to retrieve their money but couldn't contact Wood River. Neither Berman nor Geffner would identify the investors they represent.

WHOSE RESPONSIBILITY? Apart from its hedge funds, Wood River managed $75 million for the much larger Millennium Partners hedge fund in New York. Millennium, which has about $5 billion under management, pulled its money out of Wood River recently, says a person familiar with the situation. But that person wouldn't be more specific.

Until the past few weeks, Wood River was telling a relentlessly upbeat story about outperforming well-known stock indexes such as the Standard & Poor's 500-stock. The firm engaged no fewer than six outside promoters to market its hedge funds. One, Snug Harbor Capital, sent material to potential investors via e-mail as recently as Sept. 12, announcing that Wood River had beaten the s&p 500 for the month of August. Jason Okie, the Snug Harbor rep who sent the announcement, didn't return phone calls or e-mails from BusinessWeek. Fyzul Kahn, chief executive of Silver Leaf Partners Inc., a brokerage that has done work for Wood River and is affiliated with Snug Harbor, says institutional investors, not fund promoters, bore responsibility for checking hedge-fund credentials. "It really is their responsibility to dig very deeply," Kahn says. "If more institutions do that, there won't be the need for more regulation."

Wood River's claimed investment returns were all the more impressive given the tiny team of analysts listed as its staff in some promotional materials. The firm sought to reassure prospective investors by also listing as its "independent auditors" American Express Tax & Business Services Inc. and nav Consulting as its bookkeepers. But those firms say investors were misled. In the "past five years we have not had an audit relationship" with Wood River, says Deborah Ely-Lawrence, a spokeswoman for rsm McGladrey, a unit of h&r Block Inc. that bought the American Express division earlier this month. Nav Gupta, president of nav, which is in Oak Brook, Ill., says: "We have never even done any business with Wood River."

PRIOR SCRAPES. John Whittier, the son of Ronald Whittier, a former executive vice-president at Intel (INTC), worked as a media and communications analyst at Donaldson, Lufkin & Jenrette from 1991 to 1997. The younger Whittier formed Wood River in 1997 to manage family money and launched his first hedge fund six years later. There are no complaints or disciplinary actions on his record with the NASD.

But even before he got into hedge funds, Whittier had run into legal tangles. In April, 2002, investment bank Credit Suisse First Boston sued Wood River in New York state court over a botched stock transaction similar to the one that prompted Lehman to sue. The CSFB lawsuit was settled out of court.

In October, 2002, Wood River's landlord in San Francisco sued the firm for failing to pay rent for three months. That suit was dismissed. And from 2002 through 2004, the state of Idaho filed four tax liens against Whittier totaling $267,156. It couldn't be determined how those liens were resolved. "Those things in concert really made us feel ill at ease," says Randy Shain, executive vice-president at First Advantage CoreFacts, a New York research firm that vetted Wood River for two potential investors this summer. Shain urged his clients to steer clear.

CHANGES AFOOT. Now, in addition to the SEC, the California attorney general's office is looking into Wood River's actions, a spokesman for the prosecutor says. On Oct. 10, the two outside members of the board of directors of Wood River's offshore fund met without the board's third member, Whittier, to begin the process of ousting him and firing Wood River as the fund's manager, according to a person familiar with the matter.

South of Ketchum, a luxurious new flagstone house sits on property Whittier owns. No one was answering the door on Oct. 11, and it isn't clear whether the hedge-fund manager and his family will ever get to move in.

With Amy Borrus in Washington, and Nanette Byrnes, Emily Thornton, and Roben Farzad in New York

Hibbard is a corresondent in BusinessWeek's Silicon Valley bureau, and Carter is a correspondent in the Chicago bureau


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