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Is K1 Group Just Another Hedge Fund Fraud?

Posted by Larry Doyle on October 28, 2009 11:01 AM |

Fraud knows no boundaries.

I strongly believe we will see dozens of hedge funds, fund of funds, and other financial frauds revealed over the coming months. In fact, I addressed this likelihood last April in writing, “Low Tide Will Reveal Rats Scurrying Amidst The Garbage”:

Additionally, do not forget that many hedge funds suspended redemptions in the latter half of 2008. Ponzi schemes, like rats, only thrive given a steady source of food and water in the form new investments. Suspending redemptions is akin to a rat rationing its food supply. While plenty of those suspensions could be legitimate, it would be naive to think that all of them are.

What do we learn today?

Breaking news indicates that a German fund of funds, K1 Group, may very well be the next rat exposed by the global market meltdown. A legitimate fund of funds company allocates capital across a wide array of different hedge funds. We certainly know that did not happen with the funds feeding Madoff. What happened with K1 Group?

Initial reports indicate that K1 engaged in circular trading which gave the appearance of K1 managing more capital than it actually did. In the process, K1 was able to use the perceived funds as collateral for bank loans. These banks will likely take significant hits. Who are the banks? Bloomberg reports, K1 Hedge Fund Snared in Probe as Barclays, JP Morgan Face Losses:

K1 Group, the German hedge fund firm, is embroiled in an international criminal investigation after saddling banks, including Barclays Plc, JPMorgan Chase & Co. and BNP Paribas SA, with about $400 million of losses, people with knowledge of the probe said.

European and U.S. authorities are examining whether K1, which manages funds of hedge funds, deceived the banks when borrowing money to ratchet up the size of its investments, according to the people, who declined to be identified because the investigation isn’t public. German and U.S. prosecutors may announce the first charges in the case as soon as this week, they said. JPMorgan inherited its exposure to K1 after acquiring Bear Stearns Cos., which did business with the fund manager.

The inquiry focuses on whether K1, founded by German psychologist Helmut Kiener, 50, engaged in circular transactions with a network of investment firms in the U.K., the U.S. and other countries to create the illusion that K1 had more money available to backstop loans from the banks, the people said. The K1 Web site says Kiener’s investment system generated an 825 percent return from 1996 through last June.

Some comments and questions:

1. Do you think Jamie Dimon is wondering what other exposures he may have inherited from Bear Stearns that have yet to be exposed?

2. Just what exactly was the nature of Bear’s relationship? Did Bear invest in K1? Did Bear merely act as custodian and clearing agent?

3. Who are the firms with which K1 transacted? In ‘following the money,’ how many of those firms are also frauds? This trail will be very interesting.

4. Let’s focus on K1. Who was on the K1 team? The K1 Group management team consists of Mr. Helmut Kiener and . . . and . . . nobody else is listed. MAJOR RED FLAG!!

While Kiener and everybody connected with K1 are presumed innocent and entitled to due process, call me suspicious. Why? Phone calls into K1’s offices were not being answered. Interesting.

As I reviewed the K1 site, there was no depth to the material presented. A high school student with decent web designing skills could have formatted it.

Jamie Dimon must be seething.

LD

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  • Larry –

    Your first question is very important. What other toxic stuff does JP Morgan have exposure to? Losing $400 million is certainly not good for them, but the bigger question is what other losses are they potentially facing and what’s the size of those losses? This case seemed to appear all of the sudden and out of nowhere. How many other ones are out there like this? See my other comment on the GMAC post also as this ties right into that also.

    Matt

  • JP

    LD, as a fund of funds, why was K1 actively trading in the first place? Would this ever be the case with a legit operation? I’m just trying to understand how the circular trading was even possible to begin with.

  • Larry Doyle

    JP . . . from what I understand, the circular activity was likely in the form of different fund of funds placing money with an operation for a very short period of time so it appeared as if they had more money than they truly did. The money would then be utilized for purposes of gaining loans from banks to continue the scam.

    Once the loan was attained, the money would then continue “circulating.” I believe this is likely how it worked. In fact, there was probably very little real trading actually going on. The appropriate term probably should be circular transfers.

    The question now begs as to what other fund of funds or hedge funds were involved in this scam. There is no telling as to how many were involved and how large this scam actually was.

    Why and how did this happen? Lack of due diligence.

    I am very interested to know if anybody at Bear Stearns actually facilitated and benefited from this scam.

    Get an extra large popcorn for this one.






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