June 28 (Bloomberg) -- In early 2009, hedge-fund manager Philip Falcone was living the life of a newly made billionaire. He had started extensive renovations on a $49 million Manhattan mansion once owned by Penthouse publisher Bob Guccione. He traveled on a private jet, employed body guards and funded his wife Lisa’s new career as a film producer.
He was also behind an estimated $113 million in personal taxes.
To pay for the shortfall, Falcone didn’t want to use his own assets, the U.S. Securities and Exchange Commission said in a lawsuit against Falcone yesterday. The manager didn’t take a bank loan backed by his hockey team investments, Caribbean vacation home or art collection. Instead, he borrowed cash from one of his Harbinger Capital Partners LLC funds, using his clients’ money without their knowledge, according to the suit.
The regulator alleged he favored some investors, which people familiar with the firm said included Goldman Sachs Group Inc., and engaged in market manipulation, according to the lawsuit, which also named Peter Jenson, the hedge fund’s former chief operating officer. If the SEC wins its case, it will seek to ban Falcone from serving as an officer or director of any public company, foiling his ambitions to become the next Warren Buffett.
The “charges read like the final exam in a graduate course in how to operate a hedge fund unlawfully,” Robert Khuzami, the SEC’s enforcement director in Washington, said in a statement. “Clients and market participants alike were victimized.”
The lawsuit is the second blow in less than two months for Falcone, 49, a former Harvard hockey center whose hedge fund rose to $26 billion in 2008 with a successful bet against subprime mortgages. Having since suffered $23 billion in losses and withdrawals from the peak, Falcone is fighting to keep control of his empire. LightSquared Inc., Harbinger Capital’s biggest investment, filed for bankruptcy in May.
Falcone declined to comment through Lew Phelps, a spokesman for New York-based Harbinger.
“The notion propagated by the SEC that investors were harmed by that conduct or any other is not only irresponsible but completely unsupported by any evidence,” Matthew Dontzin, an attorney for Falcone, said in a statement, adding that all the charges will be “vigorously defended in the courthouse.”
In 2009, Falcone took a $113 million loan from his Special Situations fund to pay personal taxes, according to the SEC, while clients were barred from pulling money. Falcone took the loan when about 60 percent of the fund’s investors had unfulfilled requests to redeem. Falcone didn’t seek approval from fund investors for the loan, according to the suit.
Falcone and Jenson, 46, disregarded the advice of one law firm about whether to borrow money from the fund. That company said that “lending money to principals is not part of the fund’s investment program,” according to the SEC.
The law firm was New York-based Schulte Roth & Zabel LLP, according to two people familiar with the matter. Carolyn Sargent, a spokeswoman for the firm, declined to comment.
The SEC alleged that Jenson misrepresented the facts to a second law firm, which did eventually give Harbinger an opinion letter. The inaccuracies included that the tax liability was unexpected and that Falcone had no other viable source of funding, the suit said. The SEC didn’t identify the law firm.
Falcone delayed disclosing the loan for five months, the SEC said. He repaid the debt in full last year, after the SEC began its investigation, according to the lawsuit.
Charles Clark, an attorney for Jenson, declined to comment.
Under the terms of the loan, Falcone was supposed to pay interest equal to the cost of capital for the fund. At that time, the fund was paying interest of 7 percent on an outstanding loan. Falcone paid 3.66 percent, the SEC said.
The same year that Falcone took out the loan, he let some large investors withdraw $169 million in return for their vote to approve a plan to restrict client redemptions from a different fund. Harbinger concealed these deals from the independent directors and from fund investors, the SEC said. The regulator said the investors were large banks and investment firms, declining to name them.
Among the large clients were Goldman Sachs, which at the end of 2008 had $1 billion invested in two Harbinger funds, Pacific Alternative Asset Management Co., a fund-of-funds based in Irvine, California, and London-based HSBC Holdings Plc’s private-banking group, according to two people with knowledge of the deals who asked not to be named.
Michael DuVally, a spokesman for Goldman Sachs, declined to comment, as did Katrina Allen, a spokeswoman for Paamco, and Robert Sherman, a New York-based spokesman for HSBC.
Falcone grew up in Chisholm, Minnesota, the youngest of nine children. His mother was a factory worker, and his father worked at the local utility. After graduating from Harvard University in 1984, he joined a professional hockey team in Sweden, where he played until he was sidelined by a leg injury. He ended up on Wall Street in the mid-1980s and worked for firms including Kidder, Peabody & Co. in New York.
In 2001, he started Harbinger with a $25 million investment from Harbert Management Corp., a Birmingham, Alabama-based money-management company. In 2006, he put on wagers against the U.S. housing market that made him rich. With the proceeds of that bet Falcone bought the 27-room mansion. He and Lisa became benefactors of New York’s High Line elevated park and the New York City Ballet.
Lisa, who was raised in Spanish Harlem by a single mother on welfare, started her film and music production company, Everest Entertainment, in 2008. That year, they also bought a $39 million property on the island of St. Barts -- the most expensive home purchase in the island’s history at that time. He owns a Gulfstream V jet and a minority stake in the Minnesota Wild professional hockey team.
After the successful housing wager, Falcone tied his fortune as hedge-fund manager, and about $3 billion of investor assets, to LightSquared, which accounted for about 40 percent of the firm’s main fund as of April. Most hedge-fund managers have shunned illiquid holdings since the 2008 financial crisis, when they were forced to block client redemptions to avoid a fire sale, and investors have complained about the level of concentration in Falcone’s funds.
LightSquared filed for bankruptcy after the Federal Communications Commission said it would withdraw preliminary approval to build out a nationwide high-speed wireless network because it interfered with GPS devices. Last week, an affiliate of the company filed court papers seeking to borrow as much as $30 million to keep operating while under court protection from bankruptcy.
In an interview in April, Falcone said he was seeking to move away from hedge funds and build a public holding company, much like Buffett’s Berkshire Hathaway Inc., that would be better suited for long-term investments.
To that end, Falcone’s funds in 2009 bought Zapata Corp., a onetime 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 and financial products and natural resources, according to a 2010 regulatory filing.
Harbinger Group fell 13 percent on June 26, the biggest drop since 1999, after Bloomberg News reported the SEC may sue Falcone, who is the company’s chief executive officer and chairman. Falcone would be barred from those roles if the SEC lawsuit succeeds.
Beginning in 2006, Falcone and two of his funds engaged in a short-squeeze of MAAX Holdings Inc. bonds, a transaction in which a buyer limits the supply of a security to drive up prices and cause losses for investors betting against the security, according to the lawsuit.
Falcone, who had bought a large position in the bonds in April and June of 2006, was making the move amid speculation that a Wall Street firm was betting against MAAX bonds and encouraged clients to do the same, the SEC said.
“In September 2006, Falcone directed the Harbinger-managed funds to buy every available bond in the market, often purchasing the bonds from short sellers,” the SEC said. “Ultimately, Falcone raised the funds’ stake to approximately 13 percent more than the available supply of the MAAX bonds.”
Having seized control of the supply of the bonds, Falcone demanded that the Wall Street firm settle their short sales, effectively forcing short-sellers to buy the bonds at prices Falcone set arbitrarily.
The SEC didn’t identify the Wall Street firm. The firm was Goldman Sachs, according to the people, who asked not to be named because the information is private. DuVally at Goldman Sachs declined to comment.
Harbert Management settled a separate complaint by the SEC that it failed to take appropriate steps to address Falcone’s trade in MAAX bonds. The company agreed to pay $1 million, without admitting or denying wrongdoing.
“We believe the resolution of this legacy matter is in the best interest of our ongoing business, and are pleased to put the matter behind us,” Tripp Kyle, a spokesman for Harbert, said in an e-mailed statement. Harbert’s relationship with Harbinger was terminated in March 2009.
In a separate administrative and cease-and-desist proceeding, the SEC found that Harbinger engaged in illegal trades in connection with the purchase of common stock in three public offerings after having sold the same securities short during a restricted period. Harbinger agreed to pay disgorgement of $857,950, prejudgment interest of $91,838, and a civil monetary penalty of $428,975, without admitting or denying the findings.