July 15 (Bloomberg) -- As Samuel Israel grew desperate to raise money in 2004 to save his Bayou Group LLC hedge fund firm, he turned for help to a Hawaii man who promised a windfall and then conned him out of $10 million, said a U.K. investigator.

Robert Booth Nichols cheated Israel, later convicted in his own $400 million theft, in a ``prime bank'' fraud, a scheme used by con-artists promising quick riches in secret markets, the U.K. investigator said in a document filed in June in federal court in New York. U.S. prosecutors seeking to recover funds for Bayou investors won a British judge's ruling in November freezing $1 million Nichols held there, and they may be pursuing millions more in Singapore, Nichols's lawyer said.

``Israel was defrauded,'' wrote Stephen Annis, an investigator in the U.K.'s Assets Recovery Agency. Nichols, who Annis said was under investigation by U.S. prosecutors as of November, ``benefited from his criminal conduct.''

Israel hid losses from Bayou investors before his fund collapsed in 2005. He pleaded guilty and is now in prison after faking suicide and jumping bail to avoid a 20-year sentence. Prosecutors and Bayou's bankruptcy estate have sued to recover funds for investors who lost $250 million.

Bayou's lawyers asked a bankruptcy judge yesterday to order 33 investors to return $89 million. They said the payouts were fraudulent transfers under bankruptcy law and that the hedge funds and individuals who received the money should have seen the ``red flags'' of fraud. The estate has already recovered $30 million.

Bayou Lawsuit

Separately, Bayou is suing Nichols, who once claimed to have worked for the CIA, and his wife, Ellen, and U.S. prosecutors are pursuing their assets. Annis's statement, written Nov. 13, 2007, as part of a U.S. bid to freeze Nichols's U.K. account, was filed last month in Bayou's New York lawsuit against Nichols.

``This is the investors' money,'' Ross Intelisano, a lawyer who represents 20 Bayou investors, said of the funds given to Nichols. Gary Mennitt, a lawyer for the bankruptcy estate of Stamford, Connecticut-based Bayou, declined to comment.

Nichols, 65, denies wrongdoing and seeks to retain the $1 million. He said in court papers that he helped Israel invest in a legitimate, though unspecified ``project'' involving U.S. government obligations. Nichols said he had no reason to believe Israel was engaged in fraud.

``He was asked to find something, and he found it,'' Nichols's lawyer, Joseph Bainton, said in an interview, declining to elaborate. ``There are very few people capable of performing this service, for which he was paid a lump sum of $10 million.''

`Suicide Is Painless'

Israel, whose sentence in April included a $300 million fine, faces 10 additional years in prison for jumping bail. On June 9, the day he was to report to prison, his car was found on a bridge north of New York City with the words ``suicide is painless'' written in the windshield dust. On July 2, he surrendered to police in Massachusetts.

In 1998, Bayou's finance chief, Daniel Marino, and co- founder James Marquez created a sham accounting firm to serve as the fund's auditor rather than report modest setbacks. Israel admitted he led a years-long fraud as losses grew.

By 2004, with their fraud unraveling, Israel and Marino were ``desperate'' for cash and began searching for high-payout, short-term investments, according to the U.S. Securities and Exchange Commission, which sued the pair in 2005.

`Investment Scams'

``Israel sought to invest in a series of `prime bank instrument trading programs' in Europe,'' the SEC said in its lawsuit. ``These program, which themselves are an enduring staple among fraudulent investment scams, required that large sums of money be sent to various foreign and domestic banks.''

In most such scams, con artists claim to have access to a secret trading market among top banks, or prime banks, where they buy notes, guarantees or debentures at a discount, yielding high returns for investors with no risk.

``In reality, no such instruments or market exists,'' Annis, the U.K. investigator, said.

According to Annis, Israel turned to Nichols, who in a 1993 lawsuit claimed to have worked for the U.S. Central Intelligence Agency for 20 years. Nichols was also the target of a 1987 probe by the Federal Bureau of Investigation of organized crime in the entertainment industry, the Hollywood Reporter said in 1993. Bainton said he's unaware of charges being filed against Nichols.

Nichols claimed to have experience with prime bank investments, Annis said. Israel traveled in April 2004 to London, where two people referred by Nichols told him the investment was safe, Annis said.

Money Transfers

On Nichols's instruction, Israel moved $120 million through accounts in Europe and North America, and ultimately $100 million in Bayou funds made its way into a Wachovia Bank account in New Jersey, the SEC said. In May 2005, the Arizona Attorney General seized the money after concluding it was related to fraud. The $100 million will go to Bayou investors.

Also in 2004, Nichols told Israel he needed a short-term loan he'd repay with his share of their ``extraordinary profits,'' Annis wrote. Israel advanced Nichols $10 million, of which $1.06 million ended up in the U.K. account -- money now frozen by the U.S. That year, Nichols fabricated a document that made it appear as if the $10 million was a fee for services, Annis said.

Nichols ``has shown he is capable of setting up and operating a large-scale fraudulent enterprise,'' Annis wrote.

President's Cousin

Nichols said in court papers that he believed the investment was on behalf of Israel personally, that Nichols was told his services ``involved matters of national interest,'' and that a first cousin of President Bush, John P. Ellis, vouched for the legitimacy of the transaction. Nichol said the deal required him to contact representatives of foreign governments that he knew, according to court documents.

Bainton wouldn't elaborate on the investment's ``national interest.''

``Mr. Ellis attended some meetings and gave Mr. Nichols some assurance with respect to the approval of the United States,'' Bainton said. Ellis worked at GH Venture Partners in 2004, Nichols said.

``These allegations are ridiculous, and I categorically deny them,'' Ellis said in a phone interview.

Traveling

Nichols has homes in Hawaii and California, according to court papers and public records. A woman answering the phone at Nichols' California home, who said her name was Eleanor, said Nichols and his wife were traveling.

Rebekah Carmichael, a spokeswoman for U.S. Attorney Michael Garcia in New York, declined to comment, as did Israel's lawyer, Barry Bohrer.

U.S. District Judge Colleen McMahon on July 3 said she was doubtful the money paid to Nichols came just from Israel. She said she ``has not yet been apprised of any money'' in Israel's pocket ``that did not actually belong to Bayou.''

Israel, who cooperated with prosecutors after he pleaded guilty in 2005, claims he was duped. In a legal brief filed on his behalf before sentencing, Bohrer wrote, ``Sam Israel is the victim of fraud.'' Other details in the brief are redacted.

The criminal case is U.S. v. Israel, 05cr1039, U.S. District Court, Southern District of New York (Manhattan).

The bankruptcy case is In re Bayou Group LLC, 06-22306, U.S. Bankruptcy Court, Southern District New York (White Plains).

To contact the reporters on this story: David Glovin in Manhattan federal court at dglovin@bloomberg.net; Bob Van Voris in New York at rvanvoris@bloomberg.net;

Last Updated: July 15, 2008 15:18 EDT