Westgate Capital Management LLC

This post is the first under the label "Fraud Cases". In that section of the blog, I will look closely at fraud cases,past or current, involving hedge funds. The idea is not to provide a listing of cases but to look beyond the facts in order to understand what went wrong and to provide to you usefull tips on how this type of fraud could have been identified. I will try to avoid the pitfall of being "smart after the facts" and concentrate on obvious red flags.

James Michael Nicholson established his company, Westgate Capital Management LLC, in late 1999 to manage several hedge funds following a long/short equity strategy. According to the SEC the fraudulent scheme started in 2004 and the total loss to investors could be as high as $150 million.

The indictment, filled in April 23rd, 2009 describes the following fraudulent acts:

1. Misrepresentation to prospective investors through false and misleading materials
2. Misrepresentation orally to current and prospective investors
3. Misrepresentation through creating a fictitious accounting firm
4. Misrepresentation through the alteration of brokerage statements for Westgate Capital accounts
5. Misappropriation of clients assets

All the public information about this case can be found on the following website: http://www.westgatecapitalreceiver.com/

The savvy investor should have identified the following red flags:

Background Check. Without hiring an investigation firm, any investor should have detect the following information. In the NASD Notice to Members-Disciplinary Actions of February 2001, available on the Financial Industry Regulatory Authority (FINRA) website, you can read:

James Michael Nicholson (CRD #1876182, Registered Represen tative, Stony Point, New York)
submitted a Letter of Acceptance, Waiver, and Consent in which he was barred from association with any NASD member in any capacity. Without admitting or denying the allegations, Nicholson consented to the described sanction and to the entry of findings that he furnished the NASD with a false and misleading response to a request for information and failed to respond to NASD requests for information. (NASD Case #C9B000043)

Entrusting your assets with a person that has been "barred from association with any NASD member" is certainly involving some risks!

Fake accounting firm. James Nicholson established in 2008 a fake accounting firm, called Havener and Havener. He personally set up this front at 49 East 41 st Street, New York, through a virtual office arrangement, using his own telephone numbers and driver's license. A simple check with the New York State's Division of Corporations would have revealed that such company does not exist. Futhermore, The American Institute of Certified Public Accountants, which monitors most firms in the US that audit private companies, does not count Havener and Havener amongst its members according to the institute's public files available on their website.

Too good Too be true.According to the Westgate Growth L.P. track record published in the SEC's complaint the fund exhibited, for the period October 1999-December 2007, a cumulative return of 487.14%, a compound anualized return of 23.93% and a monthly volatility of 2.93%. For the same period, the S&P 500 had a cumulative return of 31.07%, a compound annualized return of 3.33% and a monthly volatility of 4.01%. Furthermore, the fund's track record exhibits a strong auto correlation which is sometimes the proof of some price manipulation.

Altered brokerage statements. In the absence of an independent administrator, as it is often the case for US onshore hedge funds, the investors must check the fund's level of assets directly with the custodians. Nicholson would have not given direct access to the fund's custodians to current and prospective investors. This behaviour would have raise a strong flag against an investment in the funds.

According to the following information, it seems that Nicholson thought to expand his scheme to investors outside the US. In fact, I found that the following funds are registered as Professional Funds with the British Virgin Islands Financial Services Commission:

WESTGATE ALPHA FUND, LTD.
WESTGATE ALPHA MASTER FUND, LTD.
WESTGATE OPPORTUNITY FUND, LTD.
WESTGATE OPPORTUNITY MASTER FUND LTD.

Only the Westgate Opportunity Master Fund Ltd. was named as a relief defendant in the SEC's complaint. Therfore, it seems like no assets was invested by offshore investors. Nicholson created those entities in 2006. The master feeder structure employed is used to aggregate in one portfolio the assets from a US onshore fund and an offshore fund.

In conclusion, I believe that enough red flags should have been identified, through an appropriate due diligence, to deter any investor from investing in any of the Westgate suite of funds.

"No short cut. Due diligence is the only way to protect your assets"