Bear Stearns' Collateral Damage

Money manager Jeffrey Epstein, BNP Paribas, and other investors are mired in Bear's troubled hedge fund that bet big on subprime mortgages

The implosion of a hedge fund often sheds some unwanted attention on the wealthy investors who chose to sink money into the venture. That's certainly the case with an 11-month-old Bear Stearns hedge fund that bet heavily on risky bonds backed by subprime mortgages and is teetering on the verge of collapse (see, 7/9/07, "Mutually Assured Mayhem").

One of the bigger investors in the troubled Bear Stearns fund is Jeffrey Epstein, a former Bear Stearns trader turned money manager for the super-rich, according to regulatory filings. Over the past year, Epstein has garnered his fair share of notoriety and sensational headlines. Last July, prosecutors in Florida charged the onetime math teacher with soliciting sex from prostitutes at his Palm Beach (Fla.) mansion. Palm Beach police also alleged that the 53-year-old Epstein paid teenage girls to give him nude massages, but prosecutors did not charge him with that offense.

"Money man of mystery"

The racy allegations involving Epstein—once labeled New York's most eligible bachelor by the New York Post—have been good fodder for the New York tabloids and gossipy Wall Street Web sites such as Now it appears Epstein may have another public relations headache on his hands over an ill-fated big bet on a hedge fund set up by Bear Stearns (BSC) last summer—right around the time he was getting into trouble with the law.

Epstein's Virgin Islands-based money-management firm, Financial Trust Company, is listed in the SEC filing as a "beneficial owner" of the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage fund. A January filing with the Securities and Exchange Commission describes Epstein's firm as having "the power to vote or dispose of" 10% or more of the equity of the hedge fund, which raised $642 million from investors last summer. But the hedge fund's purchasing power was much bigger, given its ability to borrow billions of dollars from banks such as Barclays (BCS), Goldman Sachs (GS), Deutsche Bank (DB), Citigroup (C), and Bank of America (BAC).

Epstein, who splits his time between Manhattan, Palm Beach, and St. Thomas, didn't return several phone calls. Gerald Lefcourt, one of the criminal defense lawyers helping Epstein fend off the solicitation charge, had no comment. Epstein, once described by New York magazine as an "international money man of mystery," reportedly won't take on any clients who aren't billionaires. One of Epstein's longtime clients is Leslie Wexner, the billionaire founder and CEO of the Limited Brands (LTD) retail chain.

Big Losers

Even beyond his money-management business, Epstein has cut a high-profile figure. Over the years, he has befriended powerful politicians, celebrities, and academics, including former President Bill Clinton, Donald Trump, and law professor Alan Dershowitz.

Epstein isn't the only supposedly savvy money manager to the super-rich to throw money into the Bear Stearns funds. A so-called hedge fund-of-funds managed by Paris-based BNP Paribas (BNPQY) also is listed on an SEC filing as a beneficial owner of the same beleaguered Bear Stearns fund in which Epstein invested. A BNP spokeswoman declined to comment. A person familiar with BNP's Ozcar Multi-Strategy fund, which invests in a variety of different hedge funds, says the problems at Bear Stearns should have minimal impact on Ozcar's performance.

Still, this isn't the first time the BNP fund has made a disastrous bet on a hedge fund. The Ozcar fund, and other affiliated BNP funds, invested about $49 million in Wood River Partners, a onetime $127 million hedge fund that went bust in October, 2005, amid allegations of fraudulent trading. On May 30, John Whittier, the former manager of the hedge fund, pleaded guilty in federal court in Manhattan to charges of carrying out a scheme to defraud investors in the fund. The Ozcar fund, of which little is publicly known, is looking at having invested in two big losers in its brief four-year existence.

Tainted Reputation?

The hedge fund that Epstein and BNP invested in is barely holding on after using billions in borrowed money to buy risky bonds backed by ailing subprime mortgages. The fund was down 23% for the year as of the end of April. Bear Stearns says it will provide a full accounting for the funds' losses sometime next week. In June, Bear Stearns suspended investor redemptions. Some frustrated investors are offering to sell their shares in the beleaguered hedge fund for as little as 10 cents on the dollar in the secondary market. Other investors are contemplating litigation. The Securities and Exchange Commission, meanwhile, has launched a preliminary investigation into the events leading up to the collapse of the fund (see, 6/25/07, "Bear's Big Loss Attracts SEC Attention").

A sister fund also run by Bear Stearns is faring a bit better, but that's only because the big Wall Street firm has opted to prop up that entity with $1.6 billion in loans (see, 6/22/07, "Bear Stearns to the Rescue—Sort Of"). The four-year-old Bear Stearns High-Grade Structured Credit Strategies Leverage fund was down about 10% as of the end of April. Bear Stearns has suspended investor redemptions in that fund, too. The Wall Street firm, however, has decided not to provide any financing to the younger fund, which was more heavily leveraged and indebted.

The near-collapse of the two Bear Stearns funds has sparked widespread concern on Wall Street because both hedge funds used billions in borrowed money to buy sophisticated securities called collateralized debt obligations. Popularly known as CDOs, these bond-like securities are hard-to-value investments that rarely trade. There is fear that the mass liquidation of the CDOs still held by the two hedge funds could cause a widespread devaluation in CDO prices. The trouble with the two hedge funds has already forced a management shakeup at Bear Stearns' asset management division and ultimately may end up sullying its reputation.

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