DePauw's lawsuit, filed on Oct. 12 in U.S. District Court of the Southern District of Indiana, contends that Hennessee made "untrue statements of material fact" and used "falsified" investment-performance results to persuade the university to invest in the Bayou fund. Hennessee claimed to have used "five levels of due diligence" to investigate the Bayou Superfund's performance since 1997, but that fund "did not even come into existence until 2003," the suit says.
Hennessee recommended that DePauw invest in the Bayou fund knowing that former Bayou employees had recently sued the firm and claimed that Bayou had possibly violated federal regulations, DePauw's suit says.
DUBIOUS INFO. DePauw retained Hennessee in 2003 to advise the university on how to invest part of its endowment in hedge funds. "A company that had a good track record in its field let us down," says Ken Owen, spokesman for DePauw University. "That which was promised was not delivered."
Hennessee, a New York firm managed by Lee Hennessee and her husband, Charles Gradante, is one of the oldest and best-known advisers specializing in hedge funds. Hennessee and Gradante are named as defendants in the suit. Contacted by BusinessWeek, Alex Smith-Ryland, spokesman for Hennessee Group, said he wasn't aware of the lawsuit and had no immediate comment.
In a report prepared for DePauw by Hennessee in 2003, the adviser recommended an initial investment in Bayou of $1 million with a goal of receiving 15% to 20% annual returns. The report says, "Hennessee Group has spoken to former employers of [Bayou founder] Sam Israel and other investors in Bayou. Furthermore, Hennessee has conducted a background check on Sam Israel and Bayou." The report says that prior to forming Bayou, Israel had been head trader for Omega Advisers and had been made a partner at Omega in 1994, which turned out to be untrue, DePauw's suit says.
DAMAGE ASSESSMENT. Hennessee's contract with DePauw contained a warning about possible conflicts of interest. The adviser disclosed that it may receive referral fees, directed commissions, or other remuneration from hedge funds it recommends in order to reduce the fees it charges DePauw and other clients. The contract and Hennessee's report recommending Bayou did not state whether Hennessee received any compensation from Bayou.
DePauw aims to win back its $3.25 million plus 8% interest, unknown fees paid to Hennessee, costs, and attorney's fees. The university claims that Lee Hennessee and Gradante are jointly and severally liable, meaning if they and their firm are found liable, they could have to pay the university from their personal assets as well as from their firm's.
Hibbard is a correspondent in BusinessWeek's Silicon Valley bureau