Hedging Can't Fix This - A Story of Being at a Collapsed Hedge Fund

11 months after working right after college, I was fortunate enough to stumble on a LinkedIn post looking for a junior investment analyst at a hedge fund. I pounced at the opportunity without thought, and even though it was quite a small shop ($500mm), and was fortunate enough to be hired. Coming from a non-target, this was a dream.

The Exposure Was Great At First

The first few years, the exposure was great. I learned how to model and value some of the most complex structures on the street, was mentored, understood all types of risk scenarios, learned how to hedge, represented the company in Roadshows, and worked to set myself up to move into managing a portion of the book. The only unfortunate thing was, assets that I worked on started to be less yieldy, as traders and investment managers began to see and realize there was still inherent value in these instruments. Our returns decreased each year, and since some of these instruments difficult/impossible to repo, management decided we needed to expand into other strategies to increase return and attract new investors. We tried to look at CDS, equity shorts, and non-IG corporate debt, but they didn't pan out as planned.

He Even Got a Special Toast During our Christmas Dinner

The pivot then brought in a rates and macro trader for diversification, and boy, did it work out. His returns were in the high teens. More and more money was allocated to him, and the CIO was thrilled to tout his skills and outsized returns to our investors. He even got a special toast during our Christmas dinner. Everything was great, until it wasn't.

One day a few months later, the macro trader, the CIO, and the head trader looked nervous, and continued to shuffle in and out of meetings. Something seemed off.  The next Monday, the investment analysts were pulled into a meeting with the head trader and CIO, where we were told we were liquidating the main portfolio (AON bids). They were not telling us why, and there would be no questions. Obviously, something was wrong. 

The employees continued to speculate on what was going on, to no avail. One day, the macro trader went into a meeting in our conference room. Him and the CIO stayed all day. Multiple different 'suits' that we had never seen before walked into the conference room. We all were clueless as to what was going on. Speculation continued between us on the desk.

Later that afternoon/night, I found myself being the last one on the desk. Suddenly, the macro trader walked out of the room, surrounded by the suits. He pointed out his desk, and was then asked to stand on the wall directly in front of his desk between two of the suits. Two other suits approached the desk; one then began ransacking his desk and belongings, taking every notepad, post-it, cell phone, and mail from the drawers. The other went to the desktop computer, unplugged it, and took it under his arm. When they finished, all of the suits walked out of the office with the belongings, with the trader between them. I haven't seem him since.

After word got out about what occurred, and everyone noticed his obvious disappearance, it became obvious the trader did something nefarious. Sure enough, a week later, a conference call/meeting was held where the CIO let us know the fund would shut down in the next 2 weeks.

The Trader Had Gone Rogue

It turns out, the trader went rogue and committed fair value accounting fraud. He continuously was misrepresenting LIBOR (choosing for difference sources) or other spread curves used to value his positions, inflating the returns and value. The marks, of course, were directly responsible for his compensation, netting him millions off of fake gains. When trades started going sideways, he did not own up to his position's outcome and take the loss. Instead, he utilized more funds, doubled-down on his bets, and continued to misrepresent fair value, hoping for a turn in the market to erase his losses. Eventually, the ability to cover his tracks imploded, and compliance/back office staff figured out the scheme.

Since returns were misrepresented to clients, there was no other choice to close shop, and the the firm self-reported to the SEC. We were devastated, and unemployment was in our future. There are still a few people who have yet to recover. Some co-workers were in depositions and part of the SEC investigation for years.

He Was Arrested Again...

Once the story broke, the rogue trader claimed the CIO was in on it the whole time and was using him as a scapegoat. While at first most of us thought it was plausible and probable for years (after all, it was a small shop), the tune changed when, just recently, he was arrested AGAIN by the SEC for a ponzi scheme, stealing money from neighbors, friends, and even family. To make matters worse, he was already suspended from the industry and used his families brokerage accounts to mask his identity. The most likely outcome is he will be barred from the financial industry for the rest of his life, owe millions in reparations, and potentially face jail time.

Funds Fail Much, Much More Often Than You Think

The point of the story is to bring people back down to earth to realistic scenarios that can happen to any one of us in the financial industry. Funds fail much, much more than you think. There are bad people working out there who will have no remorse for their fellow co-worker. If you ever spoke to this what I will now call sociopath, you would never, EVER, think that he would do something like this. He was one of the nicest, funniest, soft-spoken and humble people working at the firm. Clearly, his facade worked, and masked the devil inside.

This is a cautionary, interesting story that most of you will never experience. I truly hope that none of you ever experience it.

If you have any other questions or comments, please feel free to message me or ask below.