RE:NTWK/BLUEWATER
BUSINESS WEEK ONLINE
July 26, 2000
Why HedgeFund.net Is Getting Tarred by a Legal Tangle
The site wants to be the leading online authority on hedge funds. So where's the news of a suit involving its creator?
HedgeFund.net aims to be the No. 1 source on the Web for hedge-fund information -- how the funds are doing, what they're investing in, who's hot, and who's in trouble. "Almost all the news on our site is derived from having our ear to the ground," boasts James Gillies, a vice-president at HedgeFund.net, one of a half-dozen sites on the Web seeking to become the leading authority on hedge funds. With 10,000 registered users, three-year-old HedgeFund.net is probably the best known. That may not seem like a huge audience, but considering you need to be well-heeled to invest in hedge funds, the site has attracted an elite following.
But here's one thing you won't find mentioned anywhere on HedgeFund.net: a multimillion-dollar lawsuit alleging that managers for a hedge fund called Blue Water Partners defrauded investors and manipulated the stock price of Blue Water's key holding. That's because, rivals contend, HedgeFund.net's creator -- long-time fund marketer and investor Alex Shogren -- is a principal creator of Blue Water, which is offered through Tuna Capital, and a key defendant in the suit.
If you're among the New Economy affluent looking for unbiased hedge-fund information, you can gain access to sites like Shogren's by simply signing a waiver stating that you have $1 million in the bank or a steady salary of at least $300,000. The site is aimed at newly minted millionaires seeking high-risk investments that promise far greater returns than garden-variety mutual funds. But a failure to mention the lawsuit on the site raises questions about the site's objectivity and others like it. And the situation serves as a reminder that the hedge-fund industry remains largely unregulated, even as the Internet's explosive growth has made it easier to learn about hedge funds.
ANGRY INVESTORS. Shogren, founder of Tuna Group, which owns HedgeFund.net and Tuna Capital, was named as a defendant in a lawsuit filed in U.S. District Court in Brooklyn in late June. The lawsuit claims that Blue Water fund's manager, Jonathan Iseson, surreptitiously concentrated the fund's assets in a money-losing Pakistani software company called NetSol (NTWK).
Specifically, the suit claims Blue Water's accumulated position in NetSol caused a run-up in NetSol's stock price, which artificially inflated the value of the Blue Water's portfolio and increased the fees Iseson and Shogren could extract -- to $12.5 million in 2000's first quarter. Even though most if not all of that fee money has been returned to investors, according to testimony at the July 20 evidentiary hearing, investors are seeking the return of their initial investment plus punitive damages totaling millions of dollars.
From 1999 through the spring of 2000, Iseson spent $43 million of the fund's assets to purchase 2.1 million shares of NetSol, a 25% stake, according to filings with the Securities & Exchange Commission and court documents. At the time, everyone was happy. Blue Water's assets rose to $160 million as NetSol's stock price increased from as low as $4 a share to a high of $80 a share in February. When NetSol's price peaked, Blue Water ranked as one of the hottest performing hedge funds on HedgeFund.net, Shogren's site. "Every time [Iseson] got more money [from investors], he bought more NetSol shares," says Ralph Siciliano, a lawyer for the disgruntled investors.
SPIRALING DOWNWARD. But concerns began to rise about the size of Blue Water's position in NetSol, which at one point amounted to as much as 78% of Blue Water's assets. With so much of the stock's ownership concentrated in Blue Water's hands, rumors swirled that Blue Water was manipulating NetSol's stock price and other investors fled, according to the suit. The shares plummeted, eventually bottoming out around 17 a share, and on July 25 closed at 23 3/4. That sent Blue Water's assets spiraling from $160 million this year to $89 million, prompting the suit.
At issue is what, exactly, Iseson had promised Blue Water investors. The plaintiffs charge that Blue Water disregarded an agreement it made with investors that the fund would not invest more than 10% of assets in any one security or buy more than 10% of any company, according to the court complaint. Through their attorneys, Iseson and Shogren dispute the allegations. They say Blue Water managers revised the 10% ownership restriction allowing for the NetSol buildup and that investors had access to public securities filings that made it clear how much Blue Water had invested in NetSol.
The plaintiffs counter that hedge-fund investors, as a rule, don't rely on scouring SEC filings for information. At least part of the reason hedge-fund managers earn such hefty fees for their work is keeping investors apprised of the fund's status, says plaintiffs' lawyer Siciliano. Had investors been aware of Blue Water's huge NetSol stake, they might have steered clear of the hedge fund, the complaint says. "Iseson intentionally failed to disclose the Funds' NetSol investment.... The information was deliberately concealed," the suit charges.
Iseson and Shogren have denied those charges in court. Attorney Andrew Levander, representing Iseson at an evidentiary hearing on July 20, said the charges don't make sense because Iseson holds a much larger personal stake in Blue Water than the plaintiffs, and he wouldn't intentionally jeopardize his own holding. His lawyer also noted that he continues to have the support of more than 50% of the fund's 100-odd investors, many of whom are friends and family.
The plaintiffs' suit does include the charge that Iseson violated Wall Street's "short-swing rule," which says corporate insiders holding large stakes in a company -- more than 10% -- can't make short-term profits on the sale of their stock. Through a spokesperson, NetSol confirms that in June, Iseson repaid NetSol nearly $1.4 million in short-swing profits.
ILLIQUID POSITION. Outside the courtroom, Blue Water confronts one of two untenable options now that NetSol's stock price is so depressed: either sell at a huge loss from the stock's soaring highs or hold the stock until NetSol's fortunes improve. But that could be a while. NetSol is highly illiquid, meaning it is largely owned by just a few insiders, namely Blue Water and the four Pakistani brothers who founded the company. As a result, a sell-off by the fund would likely cause the stock price to collapse. NetSol doesn't have much of a Wall Street following or a track record in software or Internet technology. It also has very little in the way of sales: It lost $800,000 on revenues of $1.9 million in the most recent quarter.
Why Iseson locked the fund in such a difficult position is a mystery. Iseson, through Shogren and partner Gillies, declined to respond to repeated requests for comment. While the investors who have filed the suit charge stock manipulation, it may have been a classic case of a manager getting in over his head. Iseson may have thought NetSol was a moneymaker and when things didn't materialize, rather than cut his losses, he increased his stake.
Regardless of Iseson's motives, investors are furious. "We were defrauded," says Sandra L. Manzke, chief executive of Tremont Advisers in Rye, N.Y., a plaintiff in the lawsuit and a veteran in the hedge-fund industry. Tremont manages so-called "funds of funds," which are pools of assets invested across a wide range of hedge funds. Tremont, one of three plaintiffs that combined have almost $6 million tied up in the Blue Water fund, is no newcomer to the risks of hedge-fund investing. Tremont owns 29% of a hedge-fund Web site called HedgeWorld, which competes against HedgeFund.net.
Shogren didn't return follow up phone calls concerning the lawsuit on July 24 and 25. However, Blue Water's lawyers, speaking for the fund in court, defended the build-up in NetSol. "We have no doubt that we did not mislead people. The documents are clear," said Levander, a lawyer for Iseson.
QUIET ZONE. If this imbroglio seems like big news in the hedge-fund industry, don't look for it on HedgeFund.net. The site contains no reference to Blue Water's troubles. While Shogren issued a Mar. 8, 2000, press release reassuring investors of Blue Water's stability and supporting the heavy position in NetSol, it can't be found on HedgeFund.net. The plaintiffs charge they didn't even see the press release until May.
What's more, while Shogren discloses ties to Blue Water in fine print on the site and in fund reports, HedgeFund.net characterizes Blue Water as one of the "most popular" hedge funds among hundreds in the industry. But Blue Water's ties to HedgeFund.net go beyond being highly ranked on the site. Blue Water received seed money, marketing, and consulting from Shogren's Tuna Capital, which is also touted on the Web site. Blue Water's money manager, Iseson of Manhasset, N.Y., shares a mailing address with Shogren at Tuna headquarters in Locust Valley, N.Y, according to the HedgeFund.net Web site. In addition to naming Shogren and Iseson in the lawsuit, the plaintiffs are also suing Tuna Capital, Gillies, and a counsel for Blue Water, Arne Rovell, as defendants.
Readers of HedgeFund.net's message board claim the site has deleted postings from users who've left comments about Blue Water or queries about possible conflicts of interest at HedgeFund.net. "I've seen their message board, and I can tell you that they definitely took down postings related to this situation," charges Brian McQuade, who co-manages a competing hedge-fund information site, Hedge Fund Center. Shogren declined to be interviewed about the message board.
NO-MAN'S LAND? While HedgeFund.net remains silent on the litigation, other sites devoted to the industry have placed Blue Water's ties to Shogren front and center. Hedge Fund Center has a special section devoted to industry "debacles" that contains recent press reports and allegations about Blue Water, Shogren, and Iseson. Hedge Fund Center also has a section entitled "Catch of the Day." It recently featured a link to a story about Tremont Advisers suing Tuna Group and Iseson.
After granting a brief interview on July 17, Shogren ended it abruptly and did not return several calls seeking additional comment. Shogren describes on his site how Tuna Capital and HedgeFund.net help each other: "One of the compelling advantages of Tuna Capital's dynamic business model is our positioning of HedgeFund.net and other web sites. Through HedgeFund.net, not only do we meet 50 new investors every day, but we also meet new talents in alternative investment management."
Hedge funds have always been an unregulated industry -- a no-man's land where wealthy people pour money into arcane funds that bet on volatile stocks and currency movements, often locking investors in for years before allowing people to cash out. This is all done with the promise of much-higher-than-average returns. During the bull market and the Internet revolution of the past few years, those promises have come true frequently. The SEC doesn't oversee hedge funds, and the agency has taken an equally lenient stance toward HedgeFund.net and other sites as long as they limit their access to only accredited investors.
The lesson here? It may be wise to be cautious with these sources of information. Right now, several sites are trying to establish credibility. It's a little fuzzy whether they're offering unbiased information or marketing specific funds -- as HedgeFund.net is doing with Tuna. All of these sites are vying to become the Morningstar or Lipper of the hedge-fund industry.
But as hedge funds increasingly use the Web as a marketing tool, be careful. Throughout the Blue Water lawsuit, no one has explained how Iseson earned so much trust that he could attract tens of millions of dollars to a risky hedge fund that eventually became little more than a vehicle for his own fascination with NetSol. HedgeFund.net could explain that better than any source.
By David Shook
EDITED BY BETH BELTON
Copyright 2000 The McGraw-Hill Companies All rights reserved. Any use is subject to (1) terms and conditions of this service and (2) rules stated under ``Read This First'' in the ``About Business Week'' area.
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