Sam Wyly's Hedge-Fund Fiasco

Hiring a family friend brought lawsuits instead of fat returns

It seemed like a match made in heaven. Billionaire Dallas investor Samuel E. Wyly would launch a group of hedge funds. Russell D. Glass, a protégé of legendary financier Carl C. Icahn, would join him to run at least one of them. Wyly had known the 41-year-old Glass -- who went to Princeton University with his son Evan -- for 20 years, and welcomed him to the business like the family friend he was.

The welcome mat didn't stay out for long. Last October, Wyly started Ranger Partners, a fund focusing on shareholder activism with Glass as the manager. By April, Glass had filed suit in Delaware against Wyly, charging breach of contract and demanding at least $200 million in damages. In June, Wyly fired back with a countersuit in Delaware charging that Glass mismanaged the fund and misrepresented his investment track record at Icahn's firm. Wyly filed a separate but similar complaint in Dallas seeking at least $16 million in damages. Also in June, Wyly quietly put the fund on ice and paid investors back slightly less than what they had put in.

Through a spokesman, Glass and his attorneys declined to comment. In a statement, K. Scott Canon, president of Wyly's Ranger Capital Group, a limited partner of Ranger Partners, said: "The legal disagreements over these matters are just that -- disagreements that will be addressed between the involved parties in an appropriate manner and at an appropriate time." Each side, however, does deny the other's allegations in its responses filed in court. It's unclear when and where a trial will take place, if there's no settlement.

The dueling lawsuits offer a rare window into the secretive inner workings of a hedge fund. If Wyly's accusations turn out to be true, the case will also be a cautionary tale of someone who built a career by doing his due diligence before making an investment -- but then apparently let his guard down when hiring someone he knew. Wyly accuses Glass of overstating his earnings, investment performance, and the size of the assets he managed when he worked for Icahn, and exaggerating his role at another firm where he had worked -- all things that could have been checked out more thoroughly before he hired Glass. The upshot, Wyly's complaint concludes, is that he never should have hired Glass because he wasn't qualified to manage the fund. In his response, Glass denies the charges.

For Wyly to get involved in a tussle that has the hedge-fund world buzzing is certainly out of character for the intensely private 68-year-old Louisiana native. Over the past 40 years, the boyish-looking entrepreneur amassed his fortune with deft bets on everything from oil and silver mining to restaurants and software. Until recently, the avid history buff and staunch supporter of President George W. Bush was little known outside Texas. But then he picked high-profile proxy fights in 2001 and 2002 with Computer Associates International Inc. (CA ), which in 2000 had bought his software company for some $4 billion. Last summer, Wyly dropped the campaign -- which he said cost him $14 million -- after CA settled with him for $10 million; later the company implemented several of his suggested reforms.

Wyly then returned to the hedge-fund business. His first foray had been a big success: In 1990, he co-founded Maverick Capital Ltd., which today has some $8 billion in assets. Since 1993, son Evan, a Maverick co-founder, and former Tiger Management money manager Lee S. Ainslie III have managed the fund. Wyly is still an investor but has no management role.

It was his battles with CA that led Wyly to create the corporate governance fund. "Institutional investors suggested that he turn his experience with CA into a business," Wyly says in his complaint. The fund was to employ a "catalyst" value-investing strategy: taking stakes in companies that are underperforming due to poor governance, initiating a transforming event -- such as a proxy fight -- with the aim of raising the value of the company and its stock. As Wyly told BusinessWeek in March, he had become "a born-again, good-governance guy."

For the person to run Ranger Partners, Wyly turned to Glass, "a family friend," according to Wyly's suit. Not only had Glass and Evan attended college together but they were also later partners at Premier Partners Investment Research, an investment research boutique. Wyly says Glass ingratiated himself by, among other things, telling him that he carried photos of his grandchildren in his wallet and had photos of his son's wedding on his desk. Glass told BusinessWeek in March: "I have had a long-standing relationship with Sam and Evan that goes back to the early '80s."

That's about all Wyly and Glass seem to agree on now. They even dispute who approached whom about working together. Glass contends Wyly "solicited" and lured him away from his four-year post as president and chief investment officer at Icahn Associates Corp. in New York. Wyly contends that Glass "approached" him.

Either way, Glass signed on with Wyly in January, 2002, for a huge compensation package, which is outlined in the suits. For starters, Glass got a 60% stake in Ranger Partners. Then, one of Wyly's investment vehicles, Ranger Entrepreneurs LP, put $10 million into the new fund on Glass's behalf and, in exchange for a 35% stake in the fund, pumped in $40 million more. Ranger Entrepreneurs also invested $3 million on Glass's behalf in "a separate Wyly-controlled investment vehicle" and awarded Glass an interest in the profits. For good measure, Ranger Entrepreneurs kicked in $3 million for the fund's startup costs. What's more, Glass was to receive an annual salary of at least $350,000, plus loan commitments to help him pay taxes resulting from his interest in the fund.

Now, Wyly feels Glass snookered him. "By materially overstating his track record, Glass made himself appear to be more attractive to potential investors, which in turn induced Wyly to agree to the extremely favorable terms that Glass received," Wyly says in his suit. Glass denies this.

For his part, Glass says his agreement called on him to develop "a complex of investment funds," but claims he wasn't allowed to. Glass asserts he began developing an arbitrage fund late last year, but then Wyly yanked it away from him. In fact, in May, a Wyly-controlled company did launch a fund called Ranger Arbitrage. Wyly's suit says Glass came aboard to handle "a single fund" and that the idea for an arbitrage fund was not brought to him by Glass.

Wyly's main complaint appears to be that Glass mismanaged the fund, investing only about 18% of its capital. He claims that the majority of Glass's bets were "nonstrategic fixed-income investments" that didn't meet the fund's objective. Those that did were "tiny toehold" positions that didn't benefit the fund. Wyly's suit maintains that Glass's largest single investment was in bonds issued by HealthSouth Corp., which is now the subject of a Securities & Exchange Commission investigation. Wyly's suit says the investment lost $10.5 million. The fund ultimately raised only $179 million of the initial $350 million goal. In his response, Glass denies he mismanaged the fund.

In any case, the fund's limited partners received "nearly 100% of their money back," Wyly exec Canon said in his statement, and have put the episode behind them. But for Wyly and Glass, the divorce proceedings are just beginning.

By Stephanie Anderson Forest in Dallas

    Before it's here, it's on the Bloomberg Terminal.