Falcone’s Future Hinges on LightSquared Returns as SEC Mulls Lawsuit

A day after being told that U.S. regulators may sue him, billionaire hedge-fund manager Philip Falcone telephoned Sheldon Lowe, a close friend of 23 years, and told him that he would fight back.

Falcone, 49, who rose to fame with bets against U.S. subprime mortgages in 2007, sounded calm and determined, Lowe, a Miami-based real estate developer, said in an interview.

“I told him it’s tough to stand up to the U.S. government,” Lowe said. “But I said that I believed he would never intentionally do anything illegal or ethically wrong. He said to me, ‘You know that Sheldon.’”

Falcone may be facing his toughest challenge yet as the government considers whether to sue him over alleged violations of securities laws. The threat of a lawsuit, disclosed last week, has prompted the hedge-fund manager to plan suspending client withdrawals for a second time in three years, which may make attracting new investors difficult unless his bet on a wireless telecommunications venture called LightSquared Inc. pays off.

Falcone, in an interview yesterday, said he is moving away from hedge-fund investing and plans to use Harbinger Group Inc. (HRG), a publicly traded holding company he controls, rather than his fund Harbinger Capital Partners, to finance investments in the future. Assets in the New York-based hedge fund have slumped to $5.7 billion from a 2008 peak of $26 billion.

‘Long-Term Investing’

“I will continue to manage the Harbinger Funds to achieve the best outcome for our investors, but I will structure new investments differently,” he said by telephone. “Going forward, I’ve made a conscious decision to evolve away from a hedge-fund strategy. I am focusing on building a public company and want to do more long-term investing.”

Harbinger Capital, based in New York, Falcone, Omar Asali, head of global strategy, and Robin Roger, the general counsel, on Dec. 8 received Wells Notices from the staff of the U.S. Securities and Exchange Commission that relate to alleged “violations of the federal securities laws’ anti-fraud provisions in connection with matters previously disclosed and an additional matter regarding the circumstances and disclosure related to agreements with certain fund investors,” the New York-based hedge fund said last week.

The Wells Notices relate to an SEC investigation into whether Harbinger allowed some clients, including Goldman Sachs Group Inc., to withdraw money while barring others, the Wall Street Journal reported on Dec. 9, citing unidentified people familiar with the matter.

Goldman’s Treatment

“There was no inappropriate preferential treatment given to Goldman,” said Mike Sitrick, a spokesman for Harbinger. Andrea Raphael, a spokeswoman for New York-based Goldman Sachs, declined last week to comment on the article.

Harbinger Group said in a filing in July that Harbinger Capital is being probed by the SEC and the U.S. Attorney’s office over a $113 million loan Falcone took from one of his funds, according to a July filing. The investigation also looked into possible preferential treatment of some investors, two people with knowledge of the probe said last year.

Harbinger told clients in April that the government was looking into whether it had engaged in market manipulation in its trading of the debt securities of an undisclosed firm from 2006 and 2008. Investigators were examining a potential violation of a rule prohibiting investors from selling short a stock within five business days of a secondary offering and then buying shares in that offering, the firm said then.

‘Utterly Untrue’

Falcone declined to discuss the Wells Notices and the subject of the SEC investigations. He said last year that allegations of preferential treatment of some clients were “completely and utterly untrue.” He disclosed the loan, which was used to pay personal taxes, in the Special Situation Fund’s March 2010 financial statements.

Falcone, a 1984 graduate of Harvard University, started Harbinger in 2001. He limited investor withdrawals from his funds in the aftermath of the September 2008 bankruptcy of Lehman Brothers Holdings Inc. when credit markets froze. He segregated about 30 percent of the main fund’s hard-to-sell assets into a separate portfolio and told clients it would take as long as two years for them to get their money back.

The biggest holding in the side-pocket is a 26.6 percent stake in Ferrous Resources Ltd., an iron ore producer in Brazil that canceled plans to sell shares to the public in June 2010 because of volatile equity markets.

Suspending Withdrawals

“I should have suspended 100 percent of the redemptions in 2008,” Falcone said. “This would have given me time to sell in a more orderly fashion rather than selling positions into a down market, which did nothing but make the portfolio more illiquid.”

Falcone said he returned as much as $10 billion that year to clients who asked for their money back.

At the end of March, Falcone told clients seeking to pull their money that they would be paid in part by non-tradable shares of LightSquared. Harbinger told clients on Dec. 9 that it “anticipates” withdrawals from its main hedge fund will be suspended on Dec. 30, following the SEC’s notices.

“Any fund that limits investor withdrawals due to non- market conditions and does it a second time within a short space of time will have a hard time convincing institutional investors to allocate to it going forward,” said David Slattery, a partner at Castellar Partners, a New York-based firm that advises clients on hedge-fund investing.

Betting on LightSquared

As of May 26, LightSquared shares accounted for 62 percent of the main fund’s assets.

LightSquared faces challenges from makers of global- positioning system devices that say the service will disrupt navigation by cars, boats, tractors and planes. The service caused interference to 75 percent of GPS receivers examined in a U.S. government test, according to a draft summary of results released on Dec. 9.

Martin Harriman, executive vice president of LightSquared, said in an e-mailed statement that the firm was “outraged by the illegal leak of incomplete government data.”

The testing was requested by the National Telecommunications & Information Administration, a Commerce Department agency that oversees airwaves use. The agency is still reviewing the data, a spokeswoman said.

Investors ‘Hoping’

“Every investor is hoping this resolves in a good fashion,” said Charles Holzer, a private investor in Harbinger. “A lot is riding on it.”

To help secure more permanent capital for investments, Falcone’s funds in 2009 bought Zapata Corp., a one-time oil driller, and turned it into Harbinger Group, a holding company that can raise capital for long-term investments. Falcone plans to use Harbinger Group to finance investments in six industries, including consumer products, financial products and natural resources, according to a filing last year.

Harbinger Group in March agreed to buy Old Mutual U.S. Life Holdings Inc., a provider of fixed-annuity and life insurance products, for $350 million. In May, the company said in a filing that it’s raising $280 million from a group led by Fortress Investment Group LLC for general corporate purposes, which may include investments and acquisitions.

‘The Right Time’

The Wells Notices weren’t addressed to Harbinger Group or any of its subsidiaries, including Spectrum, and don’t affect the hedge fund’s investment in LightSquared.

Falcone said his aim is to return money to his hedge-fund investors as quickly as possible.

“I am not trying to hang onto people’s money, I’m waiting for the right time to monetize those positions,” he said.

As for LightSquared, Falcone said he’s confident the investment will pay off.

“I believe it has tremendous value,” he said in the interview. “I am not afraid to take risk and continue to believe in the wireless space.”

To contact the reporter on this story: Saijel Kishan in New York at skishan@bloomberg.net

To contact the editor responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net

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