Bayou Arbitration Decision

     The Bayou Hedge Fund Group was founded in 1996, and it raised about $450 million from investors whom it defrauded. The hedge fund lost money, but it created a fake accounting firm that provided misleading results to investors. Run by CEO Samuel Israel III and CFO Daniel Marino, the hedge fund was exposed as a fraud in 2004, and in 2005 Israel and Marino pleaded guilty to multiple charges including conspiracy and fraud, and were each sentenced to twenty years in prison.

     Creditors of Bayou brought a claim against Goldman Sachs Group, Inc. before a Financial Industry Regulatory Authority arbitration panel, which awarded the creditors $20.5 million in June 2010. Goldman Sachs’s liability stemmed from its acting as Bayou’s clearing broker, in which capacity it had ignored signs of fraud, according to the Bayou creditors and to the FINRA arbitration panel that found for the creditors.

     The case potentially involves more than the $20.5 million arbitration award against Goldman Sachs, because it sets a precedent that a clearing broker can be liable for its client’s fraud. Accordingly, Goldman appealed the arbitration award to a federal district court—and lost.

     Now Goldman has appealed the district court’s decision to the Second Circuit Court of Appeals.

     What made Goldman Sachs liable was, first, that it should have known that Bayou was using its customers’ funds rather than Bayou’s own funds, in transactions with Goldman. Second, Bayou shuffled its money among various Goldman accounts, which in effect transferred the money to Goldman so that the money could be recovered by Bayou investors. Third, Goldman ignored warning signs, including suspicious money transfers. And fourth, Bayou’s marketing materials claimed that the fund consistently made investment gains, but Goldman’s own records showed that Bayou was losing money. (See “Goldman Battles Bayou Decision,” Wall St. J. at B14 (15–16-OCT-2011);;;

     The significance of this ongoing story is that an investor who has lost money investing in a hedge fund or other opportunity that has gone bankrupt, may be able to recoup some of her losses. She may have grounds for arbitrating or litigating against a third party—such as a law firm, auditor, clearing house, or investment banker—that helped perpetrate the fraud. Attorney Stephen A. Katz is available to bring that kind of arbitration or lawsuit.

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Attorney Stephen A Katz
Stephen A Katz, P.C.

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