Angus Loten
Class of 2010
The Long Road to Redemption:
Five years ago investors in the Bayou Group discovered they were victims of a $450 million
fraud. One hundred and fifty lawsuits later, they’re still trying to get their money back.
Thesis Adviser: James Stewart
Submitted in partial fulfillment of the degree of Master of Arts in Journalism
Copyright
Angus Loten
2010
Eric Dillon’s limousine pulled up in front of a cream-colored, waterfront cottage at the
edge of Long Island Sound in Stamford, Connecticut. It was a bright, mid-August day in the hot
summer of 2005. Still groggy from an early-morning flight, on top of the 30-mile ride from
LaGuardia airport through weekday New York traffic, he knocked several times before noticing
a doorbell. No one answered. He rang the bell. No one answered that, either. He double checked
the address at the bottom of a note on corporate letterhead with the silhouetted crane logo for
Bayou, a high-flying hedge fund in which Dillon had invested millions of dollars, both for
himself and clients in a fund of funds he managed back in Seattle. It said 40 Signal Road. The
place was a bright two-story clapboard home at the far end of a quiet residential lane, closer to
Greenwich than Wall Street.
Off the entrance porch, he shielded his eyes and peered through a window at the darkened
office inside. It looked deserted and he started regretting the hasty decision to cut his family
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vacation short. But no one had answered his calls or emails in the hours and days since Bayou’s
manager, Sam Israel, had suddenly closed the fund three weeks earlier. Israel, an affable, wellconnected trader from Louisiana who spoke with a soft southern drawl, was going through a
nasty divorce and told investors he simply wanted to spend more time with his children. Though
he’d promised a full payout by midmonth, Dillon hadn’t seen a penny. Neither had any of the
fund’s other 100-plus investors who together had some $450 million in the fund. And they were
getting nervous. Still shielding his eyes from the sun, he swung around behind the office and
found a back door leading out to a sandy beach and a dock. He knocked at the door. When no
one answered he turned the knob. It was unlocked. He slipped inside calling ‘hello’ into the
empty home. Finding no one, he tapped on the one closed office door at the far end of a large,
open room with several computers and flat-screen monitors stacked on the ground. The
nameplate read Daniel Marino, the fund’s CFO. Dillon waited, then pushed the door open.
There, arranged neatly on an uncluttered desk, he found a six-page note typed on plain white
paper that began: “My name is Dan Marino and this is a combined confession and suicide letter.”
He grabbed the desktop phone and called 911.
In the weeks that followed, Dillon and the rest of the fund’s investors – including the
likes of J.P. Morgan Chase, Tremont Capital, DePauw University, and New York Mets owner
Fred Wilpon – discovered Bayou was a sham. And the millions they had invested were gone.
Marino’s letter, seized by police at the scene, laid out an elaborate scheme that was snowballing
for years and about to come crashing down. But unlike the Bernie Madoff scandal, whose
towering $60 billion scam shocked the world three years later and reduced Bayou to a mere
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footnote in the annals of Wall Street fraud, Israel and Marino never meant to rip people off. To
the bitter end, they desperately tried to spin investors’ massive losses into gains, leading to a
hail-Mary endgame rife with drugs, guns, rogue spies and a wild flight from justice that makes
Madoff’s surrender look like a weekend in the Hamptons. And as the Bayou case winds down in
bankruptcy court, its stature has grown, setting crucial legal precedent for compensating the
ever-growing number of victims of phony hedge funds, from Madoff to Allan Stanford, Bear
Stearns, Raj Rajaratnam and beyond.
Like Madoff, Bayou’s clients were an unlikely mix of small-time, individual investors
and large, professional firms with billions of dollars. What they all had in common was a
misplaced trust in Samuel Israel III. The scion of a prominent New Orleans family, Israel was a
chummy day trader who was well-liked by executives at some of the biggest firms on Wall
Street, including the Hennessee Group, Tremont Capital, J.P. Morgan Chase and Omega
Advisors, where he once worked for Leon Cooperman, a former Goldman Sachs partner. His
namesake grandfather was a coffee importer who made a fortune by expanding into commodities
trading, building a powerhouse investment firm that was later sold to Donaldson, Lufkin and
Jenrette for $42 million. Larry Israel, his father, became one of the most successful and wellrespected commodities traders in the South. His mother, Merryl Aron, was a professional golf
champion. Together, they were among top donors at Tulane University, where an environmental
sciences building is named after them. From an early age, Israel was under intense pressure to
live up to his family name. Everywhere he went, he once said, people seemed to know his
parents, either directly or by reputation: “I did not want the world to think I was not good enough
and I did not want my family to see me as a failure.”
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When his father died in 1982, Israel dropped out of Tulane and headed to New York to
make a name for himself on Wall Street. The family already owned a palatial home near the
Westchester County Club. A big guy who spoke with a soft southern drawl, one of Israel’s first
jobs was at F.J. Graber & Company, a high-velocity money management firm where a family
friend had arranged a summer internship. After that, he landed a full-time job at Gerard Klauer
Mattison. At Omega, where he worked in the early 1990s, co-workers remember him as
wisecracking fast-talker with a bad back who would occasionally lie flat out on the office floor.
Israel was in his late thirties when he started putting together Bayou sometime in the mid-1990s
with the help of Dan Marino, a skinny, half-deaf accountant with a lisp who lived with his
mother in Staten Island and drove into the city in a leased Maxima. The two had met years
earlier at a by-then defunct firm called HMR Investors. Israel’s vision for the new fund was to
offer “steady, above-average market returns while maintaining a lower risk profile,” according to
early marketing material. In it, Israel is described as a third-generation trader with “20 years’
experience in hedge funds” who once managed $400 million as a head trader at Omega. Like any
good sales pitch, many of these claims were exaggerated, if not plain-faced lies. Israel would’ve
been a teenager 20 years before founding Bayou. If he did work at a hedge fund back then, he
likely wasn’t trading. Worse still, he never traded for Omega, either. According to Cooperman,
Omega’s founder and CEO, Israel worked for him in 1994, but had no trading discretion. He was
never more than an order taker, former colleagues say. Still, Israel was able to sweet talk enough
family contacts back in Louisiana to get the fund off the ground in 1996, with Marino as a
partner and a few million dollars under management. One of its earliest investors was Martin
Payson, a former vice chairman of Time Warner who was on Tulane’s board of directors with
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Israel’s father. Payson liked Israel and often took him out to dinner in Manhattan, where he
mingled with Wall Street elite. He was disappointed when Bayou lost about 14 percent in its first
year trading, but kept his money in the fund. Jimmy Marquez, a friend of Israel’s from New
Orleans, joined the firm the following year with a good reputation and a deep client list built up
over years as a trader for George Soros. Along with Marino as CFO, the rest of the office staff
was made up of a half dozen sales associates and gofers with scant experience in financial
markets, including a recent college grad and a former high school math teacher. A loose network
of veteran salesmen – they were all men – started fanning out across the country, made up mostly
of investment advisors and other fund managers who were paid to bring new investors on board.
By 1997, the group had funneled nearly $40 million into Bayou. And it was getting noticed by
bigger fund-of-fund managers, too.
“What’s fascinating about Bayou is that it was a lot of small investors,” says Ross
Intelisano, a partner in Rich and Intelisano, a Wall Street law firm. “The typical investor had way
less than $10 million in net worth, probably less than $5 million.” A lot of money by most
standards, that’s peanuts in a lightly-regulated corner of the financial market geared to ultra
wealthy investors who, regulators assert, have at least implicitly signed off on a “big boy” clause
and can handle the downside of risky bets. What attracted less affluent investors to Bayou,
Intelisano says, was a 0-and-20 fee structure, meaning the firm took a 20 percent share of profits,
but didn’t charge a management fee. Most hedge funds operate with a 2-and-20 structure. Bayou
also had a minimum investment limit of $250,000. Low by hedge fund standards, that’s about
half the average limit. It also let you cash out in a hurry – just 30 days, compared to quarterly or
even annual redemption periods at other funds. On top of all that, Bayou was pitched as a
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conservative hedge fund, aiming for eight to 10 percent annual returns. “It wasn’t swinging for
the fences,” Intelisano says. “Just a lot of singles and doubles.” Peter Haje, another former Time
Warner executive who invested in Bayou, described the fund’s performance as good, “not
spectacular, but quite good.” As a result, most investors looked at it as a type of fixed-income
investment, like a nice, safe retirement fund that grew faster than a 401(K). Israel seldom held
positions for more than a day or two. He and Marquez invested in plain-vanilla stocks and
exchange-trade funds, steering clear of riskier commodities, currencies and derivatives. And he
liked to tell investors what he was up to in weekly email updates and semi-annual conference
calls, offering quirky observations about the economy and the market, a habit that endeared him
all the more to new clients. Though he reported returns that narrowly beat broad market indexes,
they weren’t too good to be true.
Only they were. According to Marino, 1997 was another bad year for Bayou. But in
preparing the year-end books in early 1998, he’d been able to offset trading losses by rebating
million-dollar commissions from its in-house brokerage, Bayou Securities, back to the fund. It
was a shady but legal move that took some convincing to get by the fund’s external auditor, the
New York-based accounting firm Grant Thornton. The administrative delays created tension
among Bayou’s nascent investors, and between its partners, too. “They felt that I was the cause
of the delay and that they did not want me to work with them anymore,” Marino writes in his
suicide-confession note. The other two partners squared off against him. By April, a full month
after the audits were overdue, they decided Israel’s wife, Janice, who was also an accountant,
would replace Marino as CFO in the fall. Until then, Marino kept to his bookkeeping, while
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casting around for a new job. “I merely did the tasks assigned to me while waiting for Janice to
come and take over my job,” he says.
But Israel and Marquez were on a losing streak. As the months passed, the fund’s trading
account continued to bleed cash. November came and went, December, too. And Marino kept
doing the books. Then, on the last day of trading that year, the three partners sat down around a
conference table in the Stamford office. The rest of the staff had long since gone to celebrate
New Year’s Eve in the city. Israel told them he was worried that two straight years of losses
would scare off new investors and prompt those already in the fund to pull out. Besides, he
confided to the other two in his half joking manner, he might have given Bayou’s clients the
impression that all was well, that 1998 was a breakout year and that the fund was turning a profit.
Marquez had done the same. It was part of his natural optimism, Israel said, the salesman in him
that wanted every client to be happy. And he believed it, too. Profits really were right around the
corner. All he needed was more time. But he had an idea. They were sitting on millions of
dollars in the trading account. Surely, they could afford to buy some time until things turned
around. Marquez immediately agreed, according to Marino’s account: “The view was that
moving the problem into 1999, they will be able to cover the losses through two ways: One, by
commissions, and two, by profits.” he says. But to do that, they needed books that told a very
different story for the previous year, one that wasn’t written in red ink. Both Israel and Marquez
urged Marino to write up a new ledger showing profits where losses had been. And the gains had
to be big, they said, in order to attract new investors and more cash. In the new year, when real
gains on this extra cash started rolling in, they would syphon off the top to cover the hidden
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losses. Within a few months, they felt, everything would be back on track and new investors
would be knocking down the door. It would be as though nothing ever happened.
Why did Marino go along with it? For starters, he figured, the plan wasn’t so farfetched.
“The reason why this would make sense is based on the past performance of both Jim Marquez
and Sam Israel,” Marino says, adding that before Bayou, “they had both consistently delivered
20 to 40 percent per annual returns.” Given their records for beating the market – or at least, the
records the claimed – Marino didn’t see how the recent dry patch could last. Pretty soon
something would hit. Plus, bringing in commissions was a cinch in the red-hot hedge fund
market. The fund itself had already paid millions in commissions to other brokerage firms,
usually for “worthless” services, he figured. Ramping up their own fees wouldn’t raise an
eyebrow. But beyond all of that, cooking the books meant lifetime job security for Marino, who,
after all, was already halfway out the door that December and looking for work. Israel and
Marquez might bully him into doing it – they bullied him all the time for lesser tasks, he felt –
but the bullying would end there. This he would have over their heads long after everyone
cashed out, Bayou closed, and he was enjoying retirement on a beach somewhere, possibly with
his mother in Florida as he’d always planned. Whatever his reasons, Marino agreed to do the
dirty work, just this once.
There was one hitch. Boosting gains in the fund’s financial statements was simple. Any
student in Accounting 101 could do it. But there was no paperwork to explain the earnings to the
auditors at Grant Thornton. This would be a problem. Hedge funds are lightly regulated, despite
their sudden rise in popularity since the 1990s. Between Bayou’s founding and its sudden
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collapse in September 2005, the amount of cash invested in hedge funds more than doubled to $1
trillion, according to Hedge Fund Research. By then there were over 8,200 hedge funds working
the markets (of these, some 350 were being liquidated by the end of the year). And yet, none of
them were required to register with the Securities Exchange Commission. Typically, fund
managers issue quarterly reports outlining gains and losses on broad trading strategies, but rarely
divulge actual trades. Still, investors need to know what a fund is worth and whether it’s up or
down. To keep everyone honest, that requires a certified, third-party auditor to authenticate socalled net asset values, of NAVs, combining total investment capital with prices fetched for
every stock sale and purchase over a given period. In other words, it would take documentation
that Marino couldn’t fake. The solution, which all three Bayou partners devised during that New
Year’s Eve meeting in Stamford, was to create their own auditor. Using Marino’s name and CPA
credentials, they launched Richmond-Fairfield Associates, a plausible-enough sounding moniker
for an accounting firm that would blend right in to records registered with the New York
Department of State. “All I did was send out audit confirmation letters on Richmond-Fairfield
stationary to the investors and brokerage houses,” Marino says. “I then created a fraudulent
financial statement and produced the report that was distributed to investors.” It showed Bayou
made a jaw-dropping gain of 17.55 percent for 1998. December, the books showed, was an
especially good month.
As the year began, the fund’s trumped up earnings had Marino leading a double life.
When new investors and fund managers asked about the asset values, they were directed to
Marino, posing as the fund’s independent auditor. Overshadowed by Israel, few had ever met
Marino, let alone knew he was a partner in the fund. As such, he was able to play the role of its
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auditor in phone calls, and even in face-to-face meetings. Partially deaf, Marino’s distinctive lisp
– recognizable to a handful of early clients who knew him as Bayou’s CFO – never gave him
away. Likewise, to maintain the façade of profitability, the partners paid out principle and profits
to occasional redeemers with real cash paid in by new investors, and there were more and more
of them every month. Finally, to make up for lost investment capital, they secretly recycled
proceeds from brokerage fees paid to Bayou Securities into the trading account.
They were also skimming off the top for spending cash. Israel would soon move into a
13-bedroom Georgian mansion in Bedford, New York, that he rented for $20,000 a month from
Donald Trump. The century-old house once belonged to the Heinz ketchup family. Yet within its
palatial walls, his marriage was dissolving. As Israel’s back grew worse, he stopped going into
the office as often, spending most days working a half dozen phones in bed, usually in nothing
but his underwear. He was also popping painkillers like candy, and drinking. In the summer of
1999, he was pulled over on the interstate and charged with driving under the influence and
possession of a controlled substance. The case was later discontinued. Even at this early stage,
Israel seemed to be spinning out of control. His wife, who never did take over Marino’s job,
eventually packed up and left, bringing their two teenage children with her. After a time, Israel
hooked up with Debra Ryan, a 40-something, high-priced interior decorator who used to design
window displays for Neiman Marcus and Macy’s. Israel hired her to remodel his now empty
Georgian mansion. In a 2008 interview with Marie Claire magazine, Ryan revealed that her pet
name for Israel during this period was “Elvis,” because he was always taking pills, rarely left the
mansion and kept the television on all the time. A chubby guy from childhood on, he was also
gaining weight. In all the years they were together, Ryan says she remembers Israel going into
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the office only once. Though he occasionally traveled to Europe, it was always alone. When
asked why she couldn’t come along, Israel told her he was working with the CIA on a covert
operation. And when she found fake identity cards in his room, he told her it was governmentissued cover to get him past an “intellectual terrorist” watch list in Europe. At times, when the
painkillers and booze knocked Israel out, Ryan would sometimes answer the incessant calls
coming in from traders and brokers, offering to take a message. Otherwise, she spent most days
wandering the mansion halls, she says, or out on the road with her own clients. At least a half
dozen times in the Marie Claire interview, she calls their sex life “wild”.
Marino’s private life was stark by contrast. Though he closed on a gated, colonial-style
home in Westport, he spent most of his time at his aging mother’s house in Staten Island,
referring to himself as her primary caregiver. In June 1999, he was diagnosed with Hodgkin’s
and began chemotherapy the following month. Later that summer, his mother was also diagnosed
with cancer. During this time, Marino’s involvement in Bayou started to wane. Between his own
treatments – which were replaced with radiation therapy for several months – and visits to his
mother’s hospital miles away, he only stopped by the office a few days a week. “I was always
available to help run the business, but did not keep in complete touch,” he says of those days.
But while Marino kept his end of the bargain by promoting the fund with inflated earnings, Israel
and Marino weren’t making good on theirs. They continued to lose on bad bets, and the hole they
were digging was getting deeper and deeper. Marino didn’t have the energy to play along. “I
demanded that Jimmy and Sam deal with this problem,” he says, “I didn’t want to continue like
this anymore.” They laughed it off. Marquez had started shoving Marino at the office, while
other staffers watched. There were nights when Israel, staggering from bills and booze, would
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barge into Marino’s home and slap him around, Marino says. Together, they once threatened to
beat him up if he didn’t get with the program. He took the threats seriously. “When I think back
now, it’s all a daze. I wanted to end it,” he says. Early on New Year’s Day, at the very tail end of
the 20th Century, Marino’s mother died in hospital. The next morning, he was back in the office
writing up a phony earnings report showing another banner year for Bayou. Later that week,
Israel sent an email blast to investors, saying: “As we’ve written so many times, the new age
stocks continue to ascend. It is our job to stand ever at the ready to identify any cracks in the
armor and to act when this mania ends.”
Over the next few years, closely watched funds and consulting firms took notice of
Bayou’s steady returns, recommending it to anyone who would listen. In 2002, John Mauldin,
president of Arlington, Texas-based investment advisory firm Millennium Wave, gave the fund a
big thumbs up in a widely read industry newsletter. Among other accolades, he called Israel a
“winner, one of those guys who are driven by the love of the game.” Soon, the Hennessee Group
was onboard, bringing with it deep-pocketed clients, including DePauw University and others.
Other fund-of-funds followed on reports that the funds it was hitting 17 percent returns. John
Seigesmund III, a Denver lawyer who put the minimum $250,000 in Bayou that year based on
the industry buzz, later told Forbes magazine “that was singing the song I wanted to hear.” Had
they reported 50 percent returns, Seigesmund says he would’ve “run like a scalded cat.”
Despite the inflow of cash, Israel felt they needed to do something more to trim trading
losses. All three partners were drawing millions off the fund in fees and other payouts without
turning a profit in the trading account. Even Marino was now driving a Bentley, having traded in
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the Maxima long ago. To slow the hemorrhaging of cash, Israel decided it was time for Marquez
to go. At the time, Marino worried that Israel, who he says was “becoming more and more
unstable,” couldn’t handle the pressure on his own. They agreed to bring in another trading
partner who would work remotely and get paid far less. It was also agreed the new partner
couldn’t know anything about the fictitious profits. Whoever it was, he would only have access
to the same bogus financial sheets investors saw. As a buyout for Marquez, the partners took
$3.8 million out of the trading account – without disclosing the long-term position in the firm’s
financials – and used it to buy stock in a company called KFX, a company hardware marker
based in Irvine, California. Both Marquez and Israel expected the stock to climb from three
dollars a share to seven or even eight dollars within a year. That’s how Marquez would cash out
without further depleting the trading account (KFX stock prices eventually shot up to $18 per
share, but that wasn’t for another three years and Marquez had already cut his losses and cashed
out). In his place, Israel hired another family friend from Louisiana, Paul T. Westervelt Jr., for
some $800,000 a year. As part of the bargain, Westervelt’s son was also hired, as his assistant for
$90,000.
The arrangement didn’t last. Westervelt, a 30-year veteran of the trade, had worked at
some of the biggest firms in the South, including Jonathan Rice and Company. From his office in
New Orleans, Westervelt went to work for Bayou in late 2002, digging into his deep client list
for new Bayou investors. But there was tension from the start. In conference calls with the other
partners, he complained constantly about not having the hard data he needed to sell the fund,
blaming Marino for being evasive and unhelpful. He also started asking questions about
mysterious withdrawals from the trading account, including some $7 million that went missing
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over the holidays. Of that amount, $4.2 million had been taken out by Israel himself on the day
after Christmas, he said. After months of chasing the other two partners for answers, Westervelt
wrote a formal letter to Israel on March 3 outlining his concerns with the fund’s operations. He
characterized it as unprofessional, citing possible violations of SEC and NASD regulations. He
worried about the impact on his reputation, to say nothing of the potential threat of criminal
charges. Neither Israel nor Marino responded to the concerns in the letter. Two weeks later,
Westervelt and his son were fired.
By the end of 2003, the official books on Bayou Superfund, the biggest fund managed
under the Bayou Group, reported a net gain of $27 million on $192 million in assets. The profits
were still fake, but Israel and Marino were treating it like real cash, spending $5,000 a month on
limo services, $4,000 at restaurants, and even leasing a private jet for $100,000. This was
nothing compared to the fees Bayou paid out for consulting and professional services, which had
jumped from $60,000 a month to over $400,000. From July 2003 to March 2005, a Boston-based
money management firm called Eqyty Research and Management received a total of $700,000
from Bayou Securities. The payments, according to Jeffrey D. Fotta, one of the firm’s cofounders, were for stock research and trade recommendations. It was worth every penny,
according to Marino. In the opening quarter of 2004, Bayou reported its first ever gain, and “it
was real,” Marino says, “I had so much hope for this.” That hope would soon be dashed.
Between the painkillers and his fantasy life as a Wall Street player, Israel was becoming more
and more unhinged. He was now more or less permanently holed up in a darkened bedroom in
the Heinz ketchup mansion, still working the phones, while the cartoon network flickered in the
background. His live-in girlfriend, Debra Ryan, says he was now walking around naked most of
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the time, or draped in a bathrobe. Worse still, on the rare days he did leave the mansion, Israel
was carrying a gun. One time late in the office, he pulled it on Marino, holding it to his chest as a
test of loyalty. There were other ominous signs, too. Of all the operating expenses listed on
Bayou’s books, which Marino struggled to balance, perhaps the strangest was $20,000 Israel
charged for a “counterespionage consultant.” He didn’t bother with an explanation.
Bigger problems loomed. Some of the wealthiest investors with substantial positions in
Bayou were suddenly cashing out. This was bad news. The original scheme to buy time, which
by then had been coasting for some five years, only worked if more money was coming in to the
fund than going out. A sudden run on redemptions would topple the fund and expose the fraud.
They were running out of time and money. By late 2004, all that was left of some $450 million
of accumulated investments in Bayou over the last seven years was about $100 million. In
December that year, Israel and Marino had another year-end meeting. This time, Israel wanted to
go for broke. On one of his secret trips to Europe, Israel had met a former CIA operative named
Bob Nichols, according to Marino’s account. Nichols was offering to help Israel get in on the
ground level of a high-tech company the government planned to hire to produce advanced
fingerprint scanning. The contract hadn’t been announced, so the investment was a bargain.
While these talks were going on, Nichols discovered Israel was a money manager, and not a
simple investor. That’s when he told him about a covert financial operation, run by the U.S.
government and a number of the world’s wealthiest families, designed to create the illusion of
liquidity in the global monetary system by transferring huge sums of cash around the world. It
paid off 100 percent a week in bits of accumulated interest and fees, but had a number of strict
requirements, the chief one being absolute secrecy. Others made less sense: That 70 percent of
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weekly proceeds had to go into a United Nations-approved charity; that the balance was yours to
keep, but income taxes had to be strictly applied. The more Israel told Marino about the scheme,
the more it seemed like nonsense, or a ham-fisted fraud. “But Sam believed otherwise,” Marino
says, convinced the drugs were talking. Israel felt it was the only way out, that with enough cash
the Bayou mess would be cleared up in less than 12 weeks. And he was carrying his gun.
So against his better judgment, Marino sat back as Israel withdrew the last $120 million
from the fund and wired it to a bank in London, half expecting to never see it again – what he
now refers to as Israel’s “Magical Mystery Tour.” The transfer first set off flags at Citibank,
which held Bayou’s account. In London and Germany, bank examiners took moves to
temporarily freeze the accounts, but were unsuccessful. At each stop, a contact appointed by
Nichols oversaw the transactions, including an associate named Karl Johnson. Bayou’s
remaining cash went to Hong Kong, then back to Europe and on to a Wachovia account in
Arizona. That’s where it came across the desk of Cameron Holmes, the chief counsel for
financial remedies at the Arizona attorney general’s office and one of the nation’s foremost
experts on investment fraud.
At the time, Holmes, a Harvard economics graduate who was a former cop in Portland,
Oregon, was tracking a so-called prime bank investment fraud, or PBI. In a PBI scheme,
scammers attract wealthy, naive investors to a large fund that supposedly taps into a secret,
billion-dollar market for the world’s prime banks that trades daily for guaranteed profits. The
cash is moved around rapidly from banks to brokerage houses, while helpers along the way
vouch for its origins, typically with untraceable and bizarre accounts. Over the course of the
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transfers, the cash disappears. When investors come looking for their money, the scammers –
who have been skimming off the top all along – pose as victims, blaming financial institutions
for not detecting the fraud earlier. By the time Israel’s money arrived in Arizona, there was only
$101 million left. According to transfer data, the funds were backed by a gold mine in nearby
Pinal County worth $152 billion. To Holmes, that seemed like an awful lot of money. A quick
check showed all the gold ever taken out of Arizona since statehood came to just $8 billion.
When he searched through the data trail left by the previous transfers, he discovered the money’s
handlers also claimed it was connected to the Maloof family, who owned the Sacramento Kings.
Other claims said it was part of a project to build AIDS clinics in Africa, another said it was
going to back a big-budget Hollywood film. Holmes recognized the pattern. He moved fast and
seized the funds. In the lightning world of instant wire transfers, the $101 million would have
been “in the wind,” Holmes later said, if not for an anonymous tip he received just before leaving
work on the evening of May 12. In all his experience in the state’s civil racketeering unit, going
back some 25 years, he’d never received a tip before. The caller told him to look into a wire
transfer the day claimed to be backed by a goldmine in Pinal County. Holmes has never revealed
the source of that call, saying only that it was long-distance and came from a man with a strange
voice.
Three days later, Holmes got another call, this time from a lawyer representing Karl
Johnson, the man whose name was on the seized funds. Johnson was furious, the lawyer said.
His client was the head of a Flemington, New Jersey firm called Majestic Capital Management,
and demanded to have his money released. Holmes explained that he was acting within his
power to hold the funds, and, if no criminal activity was found, Johnson would have it all back in
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no time. About a week later, he got a call from a second lawyer, this one from Los Angeles,
representing Sam Israel. He said the funds were in Johnson’s name, but were invested by Israel
and belonged to him. Holmes had never heard of Sam Israel or the Bayou Fund. His immediate
reaction was “all of it? One guy?” Israel’s lawyers spent the next few months in an Arizona court
fighting to have his cash released. But the evidence was damning and Holmes knew a scam when
he saw one. According to court records, Israel hired a man named Lewis Maloof as a managing
director of Bayou. He had no relation to the Maloof family that owns the Kings, which his
lawyer once erroneously referred to as the “Seattle” Kings, another slip Holmes caught early on.
Maloof, who was also a principal of Charles Financial, was put in charge of investing $100
million in bank instruments, which he did through Karl Johnson. Johnson and Maloof were
behind the many wire transfers. Bob Nichols, the ex-CIA agent, appears to have vanished in thin
air. If nothing else, Israel’s attempt to quash the state’s seizure proved the money was his. But
the state wasn’t going to surrender it.
On a late July night that year, Debra Ryan heard moaning coming from Israel’s upstairs
room in the dark Bedford mansion. She peered into the dimly lit space, where the phones had
finally gone silent. The cords were pulled out of the jacks. There was a bright light in the en suite
bathroom. She found Israel there sitting naked on the edge of the toilet, staring at the marble
floor, squeezing his head with both hands, and repeating over and over again: “My life is over.”
After losing his months-long appeal in Arizona, Israel sat down and wrote a one-page
letter to Bayou’s investors, saying it was “with great regret, but an overriding sense of pride and
accomplishment in a job done to the best of our abilities, that I announce the closing of the
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Bayou Family of Funds.” The move came as a shock to many. He promised everyone a 100
percent payout within a month, following a final audit. “With the exception of what I would call
‘growing pains’ inherent to the learning curve of business,” he wrote, “I feel we have done an
admirable job in the stewardship of the funds with which we have been entrusted.” Despite the
firm’s ongoing success, Israel said the “miracle” of watching his children grow into adults was
“not one I plan to miss.”
Ross Intelisano, whose Wall Street law firm specializes in fraud cases, started receiving
calls from nervous Bayou investors the day they received Israel’s letter. They were right to
worry, he says. Wildly successful hedge funds don’t close without good reason. “They were
freaking out,” he says. The letter prompted hundreds of calls to Bayou’s investor relations line,
all unanswered. In a second letter, which followed just two days later, Israel again promised cash
distributions by mid-August, adding, coyly it seems now, that he planned to “monitor the
progress of the audit closely.” Then weeks went by without a word. The few investors who were
able to reach Israel on his cell phone were cut off within seconds, after he muttered something
about a meeting with lawyers. Those who tried Marino got his raspy, meandering voicemail: “I
am receiving lots of phone calls. I am unable to pick up every call, so if you do call, leave a
message and a number. I will get back to you.” Instead of a beep, an automated, female voice
said the mailbox was full.
The day Dillon found Marino’s suicide note, local police tracked him down and set up a
rendezvous back at the office. According to Stamford Police Sergeant Gary Perna, when Marino
arrived he looked tired but relieved, as though a great weight was lifted from his shoulders. He
20
was taken to a nearby psychiatric evaluation unit. The incident made the Stamford Advocate’s
police blotter the next morning, referring only to an unnamed Bayou staffer.
By then, a much darker image of Israel and Bayou was emerging. The story went public
that week when reporters linked news tips from Intelisano with the dramatic events at Bayou’s
office the previous day, first on a hedge fund tracking blog, then in the Wall Street Journal and
the New York Times. The earliest stories centered on accounts of nervous investors who weren’t
getting answers from Bayou. Worse still, a few checks for partial redemptions they received a
week or so past the final deadline all bounced. Within days, state and federal officials announced
they were investigating the fund. Even at that point, investors could still pray it was a mere
paperwork issue, a bureaucratic tangle with regulators that big traders, like Israel, run into all the
time. Indeed, two years earlier, Israel settled a complaint by the Connecticut banking department
over shoddy records at Bayou Securities, paying a fine of just $7,500. He came clean about it in
one of his weekly newsletters. There was a chance, some felt, that this latest investigation was of
the same order. It would also explain why their money was being withheld.
It was wishful thinking. The situation took a far bleaker turn in the last week of August,
when Holmes back at the attorney general’s office in Arizona sent out a letter to Bayou
investors, explaining the seized funds. The letter outlined their rights and protections, referring to
them as “injured persons” from racketeering alleged by the state. “There is no rush in filing a
request for compensation,” Holmes said. “There will be plenty of time in which to make your
status known if you are an investor in Bayou.”
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According the Ryan, Israel spent most of this time huddled in his room, sitting crosslegged on the floor in his underwear watching SpongeBob SquarePants. She had placed two big
urns in the driveway to keep the media trucks out. When she asked about the newspaper stories,
he told her there was a vault in Europe full of documents that would exonerate him, or that he’d
been set up by the CIA. Ryan didn’t really care. Donald Trump had given them four days to
move out of the Heinz mansion. She was now busy scanning real estate sites for a place they
could afford on her modest income. As the month ended, a handwritten note tacked to the
entrance of the mansion continued to pledge cash in full for all investors. “You will be contacted
soon by the proper authorities,” the note said. “Bayou is not insolvent.” If anyone still believed
that, their trust faded for good on September 1, when federal prosecutors charged Israel, Marino
and Marquez with fraud.
By that point, the only question left for investors was: Where’s my money?
Good Faith
In short order, the three Bayou partners were arrested and charged with fraud. All three
pleaded guilty and awaited sentencing hearings that might hand down anywhere from 10 to 100
years in a federal pen. Ryan had found a small home in Armonk, New York, where Israel stayed
cooped up in a basement rec room until his April 6 hearing. Marino and Marquez were confined
to their homes.
But for their many victims, the legal battle was just beginning. There were over 100
investors with cash in Bayou when it closed. From the start, one bright side was the $100 million
22
seized by Arizona, which Holmes had every intention of turning over. By the best estimates, it
represented about a third of the fund’s total value. Holmes first started receiving calls and emails
from Bayou investors in late August in response to his letter. Most of them just wanted
reassurance that he really had the money, he says. The cash was theirs, he told them, and he
planned to turn it all over at an appropriate time. So all was not lost. Still, that left only one other
source for creditors to recoup their losses: Other Bayou investors who were lucky enough to get
out early. This would involve forcing early redeemers to share the pain in bitter lawsuits.
Through the court cases that followed, this became known as “claw-back litigation.” It’s the type
of legal recourse that can make enemies of fellow victims. To make it work, creditors needed a
strong ally in bankruptcy court, someone who approached the job with the kind of moral
conviction necessary to convince others to do the right thing, but not unwilling to use a strong
hand when they refused. What they needed was an enforcer.
He’s in his forties now, but Jeff Marwil is the kind of friend you wanted around in grade
school when a bully tried to take your milk money. For starters, he’s bigger than most bullies –
even adult sized – standing well over six feet with a bulky build and mitts for hands. Born and
raised in Chicago, he can project the calm, assured confidence of a Mike Ditka-era Bears fan.
But beyond his size and manner, he also seems genuinely aggrieved by corruption and the all-tocommon victory of the unjust over the just. He’s that guy who doesn’t hesitate to step in and
break up a fight, or talk to a restaurant manager about a miscalculated bill, or tell a teenage
subway rider to get up and let an older woman sit down. All these inclinations led him to study
law at DePaul University, after an undergrad at the University of Michigan. And while criminal
law might seem like the perfect field to champion justice, Marwil discovered there were more
23
bullies in corporate boardrooms and c-suite offices, than in the schoolyard or on the street.
Pursuing corporate law, his specialty became bankruptcy and financial restructuring at distressed
companies, and he began focusing more and more on hedge fund wind-downs and liquidations
over the years. During the dot-com bust and its fallout, Marwil made a name for himself as an
aggressive bankruptcy trustee in large-scale securities fraud cases. In early 2006, he was
contacted by an ad hoc group of Bayou investors. Calling themselves the unofficial creditors
committee, the group was made up of the fund’s largest clients, who had been meeting in New
York since late fall to draft a plan of attack. They decided to push the fund into bankruptcy.
“No one knew what to do or which direction this was going,” says Intelisano, whose
clients were on the committee and attended the strategy meetings over the winter. “Everybody
was like ‘What’s next? Who do we sue? How do we get our money back?’ It was total bedlam.”
Marwil was asked to “interview to become the receiver and the sole managing member of
the funds,” he says. It was a powerful position, and, at the time, nobody was entirely sure what
his role should be. But if there was any doubt about the general approach, Marwil was sure of his
goal: To equalize the harm of the fraud among redeemed and unredeemed investors. When he
announced Bayou’s bankruptcy filing in May 2006 – after a lengthy dispute among committee
members over the merits of Chapter 11 versus Chapter 7, which, among other benefits, promised
cheaper legal fees – Marwil put investors on notice that he intended to go after more than just
phony profits: “It is patently unfair that certain former investors received all of their money back,
plus profit, while other investors received nothing,” he told them. “These cases will be about
equality of distribution, fairness and equity.” In an interview with Bloomberg a few weeks later,
24
he said “everybody’s a victim, but it’s not fair that some are lesser victims than others.” Weeks
after taking over Bayou and filing for bankruptcy, Marwil and a team of lawyers started
contacting investors directly about their intention to file claims for all the profits and principal
salvaged from Bayou in the past two years. For some, that money had long ago gone into new
homes, college tuition fees, and retirement plans.
Typically, bankruptcy law requires unwitting participants in bogus investments to cough
up profits redeemed within two years of the discovery of fraud. By the time Bayou hit the courts,
there were a handful of high-profile cases on the books. One of the first phony hedge fund
meltdowns was the Manhattan Investment Fund. Under a 30-something manager named Michael
Berger, the fund had reported 12 to 15 percent annual returns since the mid-1990s to its 250-plus
investors. But in 2000, Berger admitted he was lying all along. The fund actually lost over $400
million on bad bets that Internet stocks would crash (when they eventually did, it was too late).
While Berger awaited his day in court on fraud charges, lawyers for his clients sent letters out to
all investors saying they intended to sue to recover fictitious profits. At the time, many viewed it
as an empty threat, or a “fishing trip,” since in bankruptcy case law defrauded investors stood
well below a fund’s directors, prime brokers and others in the order of litigation. Indeed, only a
few were eventually ordered to pay, though just a fraction of their proceeds. In the meantime,
Berger had fled the country, reappearing years later in Austria, where he was stopped for
speeding in a red Opel Corsa on the highway between Vienna and Salzburg. U.S. authorities
sought extradition, but, technically, nothing Berger had done was illegal in Austria.
Similarly, in early 2006 – about the time Bayou’s creditors committee was drawing up
strategy – a Long Island family that lost $7 million in a fraudulent investment fund called
25
Sterling Watters also sued other investors for bogus profits. The fund, launched in 1995 by a
former Merrill Lynch broker named Angelo Haligiannis, boasted eyebrow-raising returns of 35
to 40 percent a year. If that sounds too good to be true, it was. The Justice Department later
discovered that Haligiannis had inflated gains by at least $25 million through a Ponzi scheme.
The family, led by a heating-oil salesman named Jerry Drenis, sued two dozen investors,
including a former SEC operations director, on the grounds that the profits they earned were
stolen property. “It’s not their money to keep,” Drenis declared at the time. A judge agreed, and
his family was able to recoup some of their losses. Like Berger, Haligiannis disappeared before
his court date and was never seen again.
While these cases are well-known to industry insiders, the issue of compensating
investment fraud victims burst into public view in December 2008, when Bernard Madoff
confessed to operating a $65 billion Ponzi scheme for well over a decade, defrauding investors,
endowments and charities across the country. In doing so, Madoff became an instant symbol for
the greed and indifference on Wall Street that many feel plunged the world into a deep, painful
recession. Until then, Bayou had been among the biggest and longest running hedge fund frauds
the world had seen. As one bankruptcy lawyer put it, it’s now just a pimple by comparison. But
then by Madoff standards, even the $1.6 billion fraud by Texas financier Allen Stanford, that
broke two months later, seemed like small potatoes. Though overshadowed by the Madoff case,
Bayou has since taken a lead role in court. With a two-year head start, Bayou’s creditors, led by
Marwil, have been blazing a legal trail since well before Madoff and Stanford were household
names, if not legends of the Great Recession. “The Bayou decision is a very important decision,”
says Judge Robert Drain, who took over the proceedings from Judge Hardin last year. “All the
26
framework and decisions for addressing this case flows straight into Madoff.” Schmul Vasser, a
lawyer for the debtors’ counsel, describes the process as a blood-and-guts battle that brought out
the combative nature of bankruptcy in the worst way. “It wasn’t a love story,” Vasser says of the
souring relationship between debtor and creditor groups. “Nothing was easily done. Everything
was a struggle. These people were defrauded intentionally and willfully by criminals,” he says.
“There wasn’t a happy investor in the house, and I doubt that anything we’ve done made anyone
happier.”
That’s partly a result of the existing legal framework within which Bayou’s victims and
their legal teams had to work. In bankruptcy law, a key principle involved in deciding who gets
what, or who gets to keep what, is “good faith.” The concept stems from the purpose of
bankruptcy itself, which is to absolve someone from repaying a debt incurred from
circumstances beyond their control. Under the code, debts are forgiven for debtors acting in good
faith and enforced for those that aren’t, requiring an honest accounting of financial and other
information. In the end, this enables the court to deal equally with all creditors. But, as if to
muddy the waters, the code doesn’t actually define good faith. Instead, district judges have had
to develop their own criteria. One big question is whether a debt was incurred for honest or
dishonest reasons. In the Bayou case, this boiled down to a determination of an investor’s
motives for pulling out of the fund. Was it done in the course of ordinary business? To buy a
house, or take a trip? Or was there a suspicion that something was awry? In other words: Who
knew what and when did they know it? For Bayou’s investors, this was the million-dollar
question.
27
For some, the good faith designation was easy to apply. Steven Selcer, who got into the
fund early, withdrew his entire investment a year before it collapsed after he and his wife had a
second child. The couple also needed to pay private-school tuition for an older child, Selcer
argued. The baby, and the tuition check, was evidence enough. Likewise, David and Ann Fristoe,
another pair of early investors, took their money out to buy a new house. They still live there
today. Charles Lieb, who managed an investor collectively known as the Dalsy Family Limited
Partnership, pulled out when he discovered he was dying of cancer and needed to transfer
oversight for the partnership to another manager. Lieb died in 2005.
Other cases weren’t so simple. High Sierra Investments, another fund of funds, had $10
million invested in Bayou by November 2004. At the end of that year, Sierra’s biggest single
client gave notice that he wanted to withdraw some $20 million from his account. To raise those
funds, Sierra needed to take all its money out of Bayou, sending Israel a full redemption notice in
February 2005. A few weeks later, Sierra’s client lowered the amount of his original withdrawal,
prompting the fund to trim its own redemption from Bayou to $9.8 million. It even notified Israel
that the fund was “very happy to be able to preserve” its investment and “looked forward to a
long standing relationship with Bayou.” Under Bayou’s 30-day rule, Sierra would have its cash
no later than April 29. But in the weeks that followed, no checks arrived. Squeezed for funds by
its own client, Sierra’s managers sent a flurry of emails and phone calls to Israel and Marino
after the deadline came and went. Then, just two months before Bayou closed, checks started
dribbling in: $3.8 million on May 2, $2 million the next day, $1.5 million a week or so later. By
late May, it had received about $8.3 million. By that point, Sierra was so furious with Bayou it
started digging into the fund’s financials and, based on its findings, decided to close the entire
28
account. That would seem to be the opposite of good faith – pulling out of an investment after
discovering questionable financial and legal issues. Judge Hardin disagreed. Since the original
redemption request was made back in February to raise cash for its own client, and without any
prior knowledge of Bayou’s troubles, he allowed Sierra to invoke good faith and keep its
redeemed investment. According to Judge Hardin, “a redeeming investor ‘takes’ his redemption
based upon the facts and circumstances known to him on the date that he makes his request.”
They were safe.
Michael Mann was on vacation in Barbados in February 2005, when, on Valentine’s Day,
he got a call from Peter Stamos, the fund-of-funds manager who had recommended Mann invest
directly in Bayou years earlier. As part of an under-the-table agreement – since Stamos wasn’t
really supposed to advise clients on direct investments outside his own fund – Stamos was letting
Mann know they planned to get out of Bayou. Over the phone, Mann told him, “if you all are
redeeming, then I will as well.” That afternoon, he faxed a redemption notice to Bayou from his
hotel and never looked further into the matter. What Mann didn’t know, or claims he didn’t
know at the time, was that Stamos had just returned from an unsettling meeting with Israel
earlier that day and decided all was not right at Bayou. If Mann knew Stamos suspected
something was very wrong with Israel and the fund, he couldn’t have acted in good faith – even
from a sunny beach in the Caribbean. But if he did know, Judge Hardin ruled, Marwil and his
legal team hadn’t come up with any evidence for it. Besides, Stamos wasn’t acting as “broker,
financial adviser or agent in any respect” on Mann’s behalf, but merely as a friend, he said.
Mann’s money was also safe.
29
In all, 45 of 158 lawsuits against Bayou redeeming investors were settled on good faith
defenses alone, allowing them to keep their divested principal and return only the fake profits.
As a first move, the rest of the defendants filed motions to dismiss Marwil’s lawsuits altogether,
arguing, among other things, that Bayou didn’t really have creditors at all, at least as set out in
the bankruptcy code. Since there were no assets in the funds – and pretty much never were –
there was no creditor pool to speak of, they argued. A comprehensive financial analysis of
Bayou’s books ordered by the court, which came to be known as the Lenhart Report, concluded
that Bayou was insolvent from at least January 1, 2002 until it collapsed, meaning its net asset
values were less than the total amount invested in the fund. For over three years there was no
money to be owed; it was just plain stolen. Instead, these so-called creditors were really equity
holders whose shares of Bayou tanked, and, as such, they had no claim on earlier redeemers, any
more than shareholders in a fast devaluing stock. In other words: Tough luck.
But in March 2007, after hearing nearly a year’s worth of arguments on all sides, Judge
Hardin denied these motions to dismiss, ruling that all the redemptions from Bayou amounted to
“fraudulent conveyances” that creditors were entitled to under the code. It didn’t matter that, in
reality, there were no assets in the fund, Hardin said. What mattered was that every investor had
a contract claim to their original investments, and any party with such a claim is “in all respects a
creditor of the debtor,” he said. Without much fanfare, outside of bankruptcy law circles anyway,
Judge Hardin had made a landmark ruling that broadened the definition of false conveyances –
creating the kind of case-law precedent that should have Madoff investors feeling both relieved
and nervous, by equal turns. Essentially, Hardin was saying that any cash taken out of a Ponzi
scheme is done with the intent to defraud other creditors, a condition that applies to “any sort of
30
inherently fraudulent arrangement under which the debtor-transferor must utilize after-acquired
investment funds to pay off previous investors in order to forestall the disclosure of fraud,” he
wrote in his decision.
“This is the clearest authority that overpaid redemptions to Ponzi scheme investors are
inherently fraudulent, and subsequently can be recovered in bankruptcy," Jeffrey Schwartz, a
partner at Dechert, the law firm retained by Marwil, said at the time. It meant that both principle
and profits taken out of Bayou, or any other similar scheme, were fraudulent conveyances
subject to claw-back by a bankruptcy trustee. The upshot for most of Bayou’s redeemer investors
was that they were automatically deemed to be acting “on inquiry notice” or “on alert” of fraud,
unless they could prove otherwise. What do these terms mean? Citing case law, Judge Hardin
ruled that investors weren’t acting in good faith “if the circumstances would place a reasonable
person ‘on inquiry’ of a debtor’s fraudulent purpose, and a diligent inquiry would have
discovered the fraudulent purpose.” For good measure, he added an investor could be acting “on
inquiry notice” without any actual knowledge of fraud. More than just legalese, Hardin – who
once stormed out of the courtroom after a testy exchange with lawyers for Bayou’s debtors
committee – was taking a hardline approach to dealing with the professional money managers
and investment advisors, including Wall Street powerhouses like the Hennessee, who claimed to
have thoroughly checked out Bayou before making sizeable investments on behalf of their
clients. To hold on to their cash, many were now in the difficult position of admitting they either
didn’t do their homework, misled clients, or were simply incompetent. They would have to
explain to the court, and the many clients who had trusted them and lost everything, how they
missed so many warning signs.
31
Red Flags
After Marquez left, Israel almost never came into the Stamford office. But he had learned
not to leave key client meetings to Marino, who had taken to berating the firm’s other staffers
and preferred working with his office door locked. Marino, left on his own, had once charged out
of a scheduled day-long meeting with a group of prominent investment advisors after just ten
minutes, refusing to let them review the fund’s books or meet its auditor. The next day, the
advisors, who had traveled all the way from Memphis, and included friends of Israel’s parents
back in New Orleans, started pulling cash out of Bayou and telling others to do the same,
quickly. Wary of losing any more investors just as the fund was poised to hit new highs, Israel
felt, he decided to suck up the pain and take key meetings himself.
That’s how he ended up at the fund’s waterfront cottage on an early February morning in
2005. That day, Israel had a morning meeting with Peter Stamos, a money manager for Sterling
Stamos, whose clients collectively had nearly $30 million in Bayou. Including Michael Mann,
another Stamos client was New York Mets owners Fred Wilpon – who, in an ill-fated move to
diversify his portfolio, and on Stamos’s recommendation, also invested heavily with Madoff.
Among other issues, Stamos wanted to discuss “concerns about the strength of the organization,”
which had posted stellar returns and was growing fast. As a side issue, Stamos, who arrived with
his lawyer and another associate, had come across a copy of a wrongful dismissal lawsuit filed
against the fund in a Louisiana district court the previous year by Paul T. Westervelt Jr. In the
suit, Westervelt alleged that Israel and Marino were engaged in “serious SEC violations” and
took out millions of dollars in off-the-books withdrawals from the fund’s trading account. The
32
allegations, while disturbing if true, hadn’t kept Stamos from funneling another $14 million into
Bayou in the months since the complaint surfaced. But, with so much cash tied up in fund, he felt
a responsibility to his own clients to get Israel’s side of the story.
The meeting started off well, with Israel outlining an ambitious plan to launch another
super fund within Bayou to broaden its trading strategy from pure equity investing into shorter
term commodity futures, a risky move that promised to boost its assets under management to
some $2 billion. A consummate salesman, Israel exuded the kind of infectious confidence in his
ability to beat the market that had persuaded both individual investors and large, professional
trading firms to pump millions into Bayou over the years. But when Stamos brought up the
lawsuit about a half hour into the meeting, Israel’s mood changed abruptly. At first, he waved off
the issue as the grumblings of a disgruntled employee who was fired for not being a team player.
He wondered aloud why everyone was suddenly so interested in a frivolous lawsuit, as he
described it, that had already been dismissed by a federal judge. The more he talked about it, the
more agitated Israel became. A heavy man with big hands, he began slapping the conference
room desk, saying there was money to be made and he wasn’t about to get distracted by a
sideshow. Like Marino, he refused to let the group see any financial statements or meet with
Bayou’s auditor. When the meeting broke up soon afterwards, Stamos’s lawyer, an industry
veteran who had recently joined the firm, told his new boss he had a “gut feeling that they should
not be investing with Bayou and Sam Israel.” Ellen Horing, a former Stamos partner who had
recommended Bayou to Stamos back in 2002 and now had $850,000 of her own money tied up
in it, decided to cash out the second she was “walking out of that meeting,” she recalled later.
33
Over a series of wire transfers on April Fool’s Day in 2005, Sterling Stamos received $37
million in redemptions from Bayou after that meeting, including principal and profits. Their
instincts proved right. But, in bankruptcy terms, they weren’t acting in good faith. Now all that
money would have to be turned over to Marwil.
Stamos wasn’t the first fund manager to come across Westervelt’s lawsuit. Lee
Giovannetti, the co-owner and CEO of a Memphis, Tennessee-based investment advisory firm
called Consulting Services Group, or CSG, had a longstanding and lucrative relationship with
Bayou dating back to its earliest days. Giovannetti received trade commissions from Israel for
referring clients to Bayou. His own investment fund, Centennial, put money in Bayou back in
September 2000. Giovannetti also acted as an official reference for Israel, talking up the fund to
potential investors. His contact info was listed in Bayou’s marketing material. Through a whollyowned subsidiary, Alternative Investment Strategies, CSG also had dozens of its own clients
invested in Bayou. Giovannetti once helped the son of a CSG partner get a job at Bayou
Securities. In March 2004, his firm invested in one of Bayou’s offshore funds in Barbados on
behalf of a client, ERF Hedge Fund. When two months passed without receiving a statement of
net asset values from the offshore fund, as Giovannetti requested, he emailed the administrator
directly. He was told to contact Marino, since the offshore fund didn’t price securities or
calculate asset values itself. It was a potentially alarming revelation. How could anyone but the
fund administrator calculate these values with accuracy? When Giovannetti called Marino, he
denied this and promised to look into the matter. A few weeks later, the data arrived from Bayou,
not the offshore fund administrator. No explanation was given. That lack of transparency didn’t
sit well with CSG’s Investment Policy Committee. It enlisted TrackBack Reports, a hedge fund
34
screening service, to look into Bayou. The report it filed in late May included a copy of
Westervelt’s lawsuit, among other findings. TrackBack investigators said they were led to the
lawsuit by Westervelt himself, who they contacted for a routine interview with a former Bayou
employee. Westervelt had told them “you’re doing the right thing” in checking out Israel.
After reviewing the report, Giovannetti called Israel, who said Westervelt was just a
“disgruntled employee” with a chip on his shoulder. Giovannetti later said that satisfied him
“because I trusted Israel.” Still, within days he emailed Marino about setting up a meeting at the
Stamford office, hoping to clear up a few nagging items, including the offshore asset values and
aspects of the lawsuit. He also wanted permission to “discuss with Bayou’s independent auditor
the procedures used in preparing the annual audit reports,” Giovannetti said in the message. “We
are willing to spend as much time as necessary on our visit to resolve these issues,” he said,
adding that he didn’t expect the visit to last more than a day, but was prepared to stay longer. He
waited about three weeks, but Marino didn’t reply. He tried contacting Israel, but again, no reply.
By June 17, Giovannetti had enough. He sent an email to all CSG advisors, saying they were
pulling all clients out of Bayou as soon as possible. In bold type, he told staff to go through every
investor portfolio and “MAKE SURE THAT ALL OF YOUR CLIENTS ARE COVERED.”
One of its biggest clients was a fund of investments owned by the local Christian
Brothers High School, which had $1.6 million in Bayou. Its board of directors was chaired by
Thomas Sullivan, a CPA with experience as a forensic auditor. On Giovannetti’s advice, he told
other board members they should get out of Bayou quick. To Sullivan, it was a no-brainer: “How
do you know how well you’re performing if you don’t know what your net asset value is?” The
35
board agreed. As one member put it, “yesterday is not soon enough.” Randy Joseph, the director
of KFI Capital Partners, another CGS client, put it this way: “Hedge funds are unregulated
investment partnerships and if you’re not comfortable with them for whatever reason, you get
out the next time you can.”
When Marino got wind of CGS’s internal email and the move to withdraw its clients, he
immediately contacted Giovannetti to set up a meeting. Beyond a mere delay tactic, it’s unclear
why he did. When Giovannetti and two Centennial executives finally arrived at the waterfront
office in Stamford on June 22, Marino refused to answer any questions. He wouldn’t say
anything about Westervelt, he wouldn’t provide prime broker statements for the offshore funds,
and he refused to arrange a meeting with the auditor. After just ten minutes, Marino threw them
out. The next day Giovannetti sent a formal letter to Israel saying, among other things, that
“independent verification is a critical component in preventing fraud, one of the more significant
risks in hedge fund investing.” He regretted they had no choice but to withdraw all their cash,
since Bayou was “unwilling to share your side with us so we are left only with the story of your
accuser.”
Though Westervelt’s suit was later dismissed and settled out of court, the damage to
Bayou was done. Along with TrackBack, the lawsuit was also unearthed by
CheckFundManager.com, a freelance due diligence firm. In October 2004, a fund of funds called
Freestone Low Volatility Partners obtained a copy of CheckFundManager’s review of Bayou,
along with a composite of CSG’s TrackBack report. At the time, Freestone had $5.8 million in
Bayou. “I saw some stuff in there that was a little disturbing,” Gary Furukawa, Freestone’s
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manager, says about the two reports. On top of the Westervelt lawsuit, the reports showed Israel
had never graduated from Tulane, though Bayou’s marketing material claimed he had. They also
showed his arrest for drunk driving and drug possession back in 1999. Concerned about “the
integrity of Sam Israel,” Furukawa set up a conference call with Marino. Like the CGS meeting,
it didn’t go well. “It was the same kind of evasive, not really answering our questions, not really
shedding any light on what really happened. Just bullshit,” Furukawa says. That day, he sent
Bayou a redemption request for Freestone’s entire investment.
Westervelt wasn’t the only Bayou employer to sound the alarm about Israel and Marino.
Howard Kra was a Maryland-based pitchman for Bayou who sold the fund to friends and former
brokerage clients. In early 2004, Kra’s biggest source for new accounts, Lydian Wealth
Management, told him the FBI was investigating Bayou, according to court records. While that
doesn’t appear to be true, Kra resigned within weeks and took all his clients with him.
For most of these high-end fund managers and advisors, Bayou didn’t always pass the
smell test. But, they argued in court, a reasonable level of due diligence wouldn’t have found
anything illegal at the fund. Indeed, a number of claims by investors against the high-paid
advisors who recommended Bayou were rejected by the district court on the grounds that routine
due diligence wouldn’t have made any difference. These included claims against Hennessee,
which later settled with the SEC on a related charge for several million dollars. There’s a similar
case pending against Goldman Sachs that is expected to be drawn out for years to come. Still,
beyond the advisors’ due diligence, efforts by banking authorities, the FBI and the SEC all
appear to have failed to detect any wrongdoing at Bayou.
37
But at least one firm uncovered the fraud with a single phone call. Altegris Investments, a
registered broker-dealer, had a selling agreement with Bayou back in early 2002. At a meeting in
June 2004 – just days before Giovannetti’s ill-fated, 10-minute meeting with Marino – it also
discovered that net asset values for Bayou’s offshore fund were being prepared by Marino
himself. After Marino refused requests by Altegris to review the fund’s prime broker statement,
they decided to look into it themselves. As a preliminary step, an Altegris accountant called the
New York Department of State records to get contact info for Richmond-Fairfield, the firm listed
as Bayou’s independent auditor, and to check that it was a registered accounting firm. It was. But
its registered agent was Marino. Worse still, the two accountants named as Richmond-Fairfield’s
founding partners didn’t exist. Confused, the accountant emailed Marino asking for a “written
explanation of your relationship with Richmond-Fairfield” along with details about when he left
the firm and started at Bayou, and why it was retained as the auditor. “You might also address
why the New York Society of Accountants still records you as the member-manager,” the email
asked. Marino never replied. Two days later, Altegris told its clients to get out of Bayou. With
one call, the firm discovered the independent auditor listed in Bayou’s published financials was
false. That’s fraud.
In the end, most of these giant investment firms, along with a handful of smaller
investors, were forced to pony up to the creditors’ pool, both with profits and principal. Records
show Dillon’s own fund, Silver Creek, put in a quarter of million dollars. These days, the case –
which long ago was moved from Wall Street’s doorstep to a modest courtroom in a federal
building in White Plains, New York – has boiled down to legal teams from all sides arguing
38
about fees incurred in all the adversarial and arbitration hearings over the past five years. It
matters, since the fees are drawn from the total amount of retrieved Bayou funds. Some have
argued that creditors would have been better off to settle early on, rather than pursue costly
litigation. Drudge Drain disagrees. “The potential recoveries were quite large and worth fighting
for,” he says. Besides fees, he adds, the case was a pioneering effort that can’t be gauged solely
on legal costs. “The litigation was going to cover some uncharted paths.” As of April 2010,
nearly five years after Holmes seized Bayou’s last $100 million, investors who initially lost
everything stand to receive about 50 cents on the dollar. Distributions, including the cash seized
in Arizona, have already begun and will likely continue well into the year.
“When the news first broke, people thought they weren’t going to get anything back,”
says Intelisano, whose 15 clients had a combined $18 million in Bayou. “It’s a victory.” To put it
in perspective, he adds, others lost far more when the financial markets crashed in 2008.
That year, Israel and Marino were sentenced to 20 years in prison. Marquez got ten years.
As a result of his back and addiction to painkillers, Israel was ordered to serve his time in a
minimum security medical facility in Brooklyn. At his hearing, where Ryan had arrived dressed
in black as a sign of mourning, she says, Israel was given six weeks to voluntarily report to the
facility. Until then, he was allowed to return to the couple’s Armonk home to put his affairs in
order. About a week later, Israel called Ryan from an auto body shop in a neighboring town. He
needed her help attaching a blue Yamaha scooter to the back of a 2007 Coach Freelander RV.
Ryan says she drove to the shop and bawled him out, calling him an “asshole” for putting her in
a dangerous situation. But the sight of her boyfriend straining his back to lift the scooter was too
39
much. So she helped. They returned to the home and said nothing more about it. Then, on the eve
of his incarceration date, the couple ordered Chinese food and went to bed. About midnight,
Ryan says Israel went out for cigarettes. After an hour or so, she fell asleep. Sometime around 1
a.m. she was startled awake by the sound of Israel crying. He was covered in sweat and yelling ,
“I can’t go to prison!” He started dragging the boxes he’d packed for storage into the garage and
loading them into the camper. Ryan didn’t know what he planned to do. Flee the country in an
RV? It didn’t make any sense, she says. About two in the morning, he got behind the wheel and
told her to follow him in her own car. She did. In the half-light of a clear summer night, she
tailed the Freelander down Interstate 684, heading south through Westchester and Putnam
Counties in suburban New York, until he pulled over at a nondescript rest stop where he parked
the camper and got into her car. They drove back to Armonk, saying little to each other. At the
house, Israel sat at a desk and wrote what he called a suicide note. Ryan says they argued for a
few more hours until she got into bed. When he finally joined her, she says, he asked for help
one more time. She refused, and he left. The next morning, state troopers found Israel’s GMC
Envoy abandoned at the side of the road in front of the Bear Mountain Bridge, spanning the
Hudson River about 40 miles outside of Manhattan. The keys were still in the ignition. Scrawled
over the hood in dust were the words: “Suicide is painless.”
Police didn’t buy it for a second. They immediately put out an APB on Israel, warning
that he was armed and dangerous, a suicidal fugitive with a bad drug habit and a thing for
handguns. A nationwide manhunt followed. Within a few days, Israel and Ryan were featured on
America’s Most Wanted. Israel’s business cards, identifying him as the CEO of the Bayou
Group, appeared on eBay. In financial circles, betting pools put money on where and when he
40
would surface. Throughout, Ryan told police she had no clue to his whereabouts. After ten days
of relentless interrogation from investigators, she confessed to helping with the camper and was
put under arrest. It was the lead item that night on all the national newscasts. A recent interior
decorating client put up the $75,000 in bail. The next day, Ryan found a message from Israel on
her voicemail. All he said was, “I’m so sorry, baby.”
That morning, Israel was riding the Yamaha scooter down the main highway from
Granville to Southwick, Massachusetts, wearing shorts and a baseball cap. He’d also grown a
shaggy beard. After a long phone call with his mother back in New Orleans, he’d agreed to turn
himself in – he didn’t know it, but his mother called police after they spoke. She was helping
investigators are along. Since watching Ryan’s arrest on the news, Israel had swallowed 175
morphine tablets and ate a pile of fentanyl transdermal pain patches back in the camper. Finally,
just after 9 a.m., and still on the phone with his mother, he turned into the parking lot at
Southwick Police Headquarters. Police were waiting for him. In the end, the stunt added an extra
ten years to his sentence.
From his prison cell in Arkansas, Marino is resigned to serving out his time. These days,
one of his biggest fears is being lumped in with Madoff in the rogues gallery of hedge fund
scammers. He thinks that’s unfair. Madoff, he points out, never made any trades or attempted to
earn any money. In that sense, it was a “true Ponzi scheme,” he says. By contrast, Bayou tried to
extricate itself from the mess it caused, though unsuccessfully. To his mind, there’s a big
difference. At the same time, he doesn’t mean to diminish his guilt. “I don’t deny my role,” he
says, “I simply know many do not understand what really happened and why.” Indeed, where
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others point to failures by the SEC, the FBI or other agencies to detect the fraud, Marino has
come to accept the biggest failure was his own. “Bayou had nothing to do with subprime
mortgages, credit default swaps or other interesting financial products. Simply put, Israel, and to
some extent Marquez, failed to trade profitably, and they induced me to believe they were in a
bad rut,” he says. “The only regulatory impact is that regulators never discovered it.” It’s a
testament to his wizardry with numbers. Perhaps, he wonders, that might yet save his
professional reputation. It would be his only redemption.
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Source List
Source
Daniel Marino
Contact Info
FCI Forrest City Low
Federal Correctional Institution
P.O. Box 9000
Forrest City, AR 72336
Debra Ryan
4 Bryan Brook Place
Armonk, NY
(518) 828-5113
Ross Intelisano
Rich & Intelisano LLP
111 Broadway, Suite 1303
New York, NY
(212) 433-1480
Thomas Sullivan
7650 South County Line Road
Burr Ridge, Illinois
(630) 323-3725
Jeff Marwil
Porskauer LLP
3 First National Plaza
Chicago, Ill.
(312) 962-3540
Eric Dillon
Silver Creek Capital
1301 Fifth Ave.
Seattle, Wash.
(206) 774-6000
Paul Westervelt
Coker & Palmer
1667 Lelia Drive
Jackson, Miss.
(601) 354-0860
43
.
Post Script
Market crashes and downturns have a tendency to unmask any number of Wall Street investment
scams, both by individuals and large institutions. Many of these are now forever associated with
the Great Recession of 2008, such as Bernard Madoff or Alan Stanford. The Bayou case broke
years earlier and was largely overshadowed by these billion-dollar schemes and unrelated to the
economic slump. But with a head start in court and little media fanfare, Bayou creditors and their
legal teams in 2009-2010 were still developing the legal framework in which hedge fund fraud
victims could seek compensation, including those duped by Madoff. Five years ago, the fund’s
shocking collapse made headlines and led nightly newscasts, yet here its full impact on the
industry was still playing out. And it was a great story.
The reporting began with a review of the many legal documents filed in bankruptcy court. This
included hundreds of pages of lawsuits, hearings and court rulings. By contacting the lawyers
involved on all sides, I hooked up with Ross Intelisano, a lawyer representing a dozen or so
Bayou creditors. Intelisano’s firm was among the first to get involved with the case. He had a
wealth of data and sources. Among these was Daniel Marino’s suicide/confession note, a sixpage typed document that chronicled the fraud on a year-by-year basis. I wrote to all three Bayou
principals, who were each in separate federal prisons by then, but only heard back from Marino.
We exchanged letters and tried to arrange an interview. Unfortunately, the paperwork had not
cleared before the thesis deadline. Still, Marino’s written confession and letters from prison
provided ample material to offer a behind-the-scenes look at Bayou’s daily operations in the
years leading up to its collaps.
In the meantime, I went to a series of arbitration hearings in White Plains and met with several
lawyers involved in the case. I also traveled to Chicago to meet with Jeff Marwil, the bankruptcy
trustee.
Perhaps the biggest frustration in reporting this story was that nearly every investor and advisory
firm I contacted had already settled with Bayou or some other entity and was legally bound by
confidentiality agreements. For the most part, I was limited to fact-checking material from court
transcripts or contemporary media reports. At times, though, this provided additional
information, such as details of Eric Dillon’s discovery of the suicide note.
(30)
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