Order Code RL33746
Hedge Fund Failures
December 4, 2006
Mark Jickling
Government and Finance Division
Alison A. Raab
Knowledge Services Group

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Hedge Fund Failures
Summary
The growth of hedge funds — private, high-risk, unregulated investment pools
for wealthy individuals and institutions — has been a striking development in
financial markets. There are now about 8,000 funds with a total of over $1 trillion
under management; both figures are roughly 10 times what they were a decade ago.
Hedge funds are said to account for 30% of trading volume in U.S. stocks and (at
times) even higher proportions in more specialized instruments such as convertible
bonds and credit derivatives. Their trades can move markets.
Since hedge fund investment is limited by law to the very wealthy, who are
presumed to be capable of understanding the risks and bearing the losses of financial
speculation, the traditional view has been that there is no public interest in regulating
them. Many still hold this view. However, as their size and presence in the markets
has grown, hedge funds have attracted scrutiny from regulators and Congress. Does
hedge fund trading now create risk exposure outside the relatively narrow circle of
their principals and investors? There are two ways this could happen.
First, the failure of a very large hedge fund, or a number of funds with similar
portfolios, could pose risks to banks and other creditors. If hedge funds had to
liquidate a large market position quickly, prices could fall sharply, widening the
circle of losses. Since markets have limited information about hedge funds, rumors
about the solvency of large funds could spread panic when markets were already
under stress. The possibility that hedge fund failure might cause other financial
dominoes to fall is called systemic risk. The best-known example occurred in 1998,
when the Federal Reserve organized a rescue of the Long-Term Capital Management
(LTCM) hedge fund, because it judged that default posed an unacceptable risk of
disruption to the financial system.
Second, investor protection concerns have emerged as the popularity of hedge
fund investment has grown. Hedge funds are open only to “accredited investors,”
defined as those with over $1 million in assets. In the past, this standard seemed high
enough to exclude the small, unsophisticated investors who provide the rationale for
government regulation. However, since the $1 million figure includes the value of
an individual’s residence, rising home prices have lifted many who are not
necessarily expert in financial matters over the “accredited” threshold. At the same
time, institutional investors like pension funds are placing more of their money in
hedge funds, which means that rank-and-file workers, retirees, and others may be
unwittingly exposed to hedge fund losses.
This report lists major hedge fund failures since LTCM. Because hedge funds
are unregulated and do not file public financial statements, reports of the amount of
losses and the reasons for failure are usually second hand and subject to inaccuracies.
The list is based on sources CRS considers generally reliable, but there are real limits
on the availability of information. For a general discussion of hedge funds, see CRS
Report 94-511, Hedge Funds: Should They Be Regulated? by Mark Jickling. This
report will be updated as events warrant.

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Contents
Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Why Hedge Funds Fail . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
List of Tables
Table 1. Selected Hedge Fund Failures and Losses Since Long-Term
Capital Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

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Hedge Fund Failures
Background
In 1998, the Federal Reserve Bank of New York organized a rescue of Long-
Term Capital Management (LTCM), a hedge fund that was on the brink of collapse.
In exchange for providing about $3 billion to meet the fund’s short-term obligations,
14 of LTCM’s chief creditors (including several of the best-known Wall Street firms)
became the new owners of the hedge fund’s portfolio. The Fed’s intervention was
very unusual. Because investment in hedge funds is by law limited to wealthy
individuals and institutions, who are presumed to be capable of understanding the
risks and bearing the losses of such investment, regulators do not normally view
hedge fund failure as cause for government action. Their strong preference is to let
hedge funds default, rather than send a signal to other market participants that they,
too, might be rescued from their mistakes.
In the LTCM case, however, the Fed concluded that default might have
repercussions beyond the losses that would accrue to the hedge fund’s principals and
investors.1 Investors had about $3 billion in LTCM, but the fund had borrowed to
accumulate a bond portfolio of about $100 billion, and had assumed derivatives
positions with a notional value of about $1 trillion. From the Fed’s perspective, a
default might have jeopardized the solvency of LTCM’s creditors, which included
several of the world’s largest financial institutions, and its numerous derivatives
counterparties. Moreover, if LTCM had been forced to liquidate its positions
quickly, prices of bonds and other instruments might have been severely depressed,
and other holders would have suffered unexpected losses, even though they had no
dealings whatsoever with LTCM. Given that global markets were already under
stress at the time — Russia had defaulted on its sovereign debt and Asia was
experiencing a second round of financial crises — and investor confidence was low,
the Fed chose to intervene rather than risk widespread disruption to the financial
system.
The possibility that the failure of a single institution could set off cascading
failures throughout the financial system is known as systemic risk. The classic case
is a banking crisis, where trouble in one bank can trigger runs on others, including
financially sound institutions, if enough cautious depositors decide to withdraw their
funds. With LTCM, regulators recognized that hedge funds can also be a source of
systemic risk. There are several possible scenarios. First, a single hedge fund could
grow large enough to pose a systemic threat if its investments were concentrated in
a single market and constituted a significant share of that of that market. In practice,
1 For more on the LTCM near-default, and on hedge funds generally, see CRS Report 94-
511, Hedge Funds: Should They Be Regulated? by Mark Jickling.

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CRS-2
this is unlikely to happen, as suggested by the case of the Amaranth hedge fund,
which collapsed in September 2006, after losing about $6 billion in natural gas
markets, without any discernible impact on the price of gas or other energy
commodities. The risk increases, however, if a number of hedge funds make similar
investments and incur losses simultaneously, or if other institutions (such as
commercial or investment banks) copy hedge fund strategies.2
(Hedge funds may also generate systemic risk when they are successful. During
the Asian crises of 1997-1998, central bankers and regulators in several countries
blamed hedge funds for manipulating currency prices and doing serious harm to the
real economies. In addition, some observers believe that hedge fund speculation
played a role in high and volatile U.S. energy prices in 2005 and 2006.)
Post-LTCM perceptions of systemic risk are not the only policy concern
associated with hedge fund failure. As hedge fund investment has become more
popular, new investor protection concerns have emerged. Hedge funds are open only
to “accredited investors,” defined as those with assets worth over $1 million. In the
past, this standard seemed high enough to exclude the small, unsophisticated
investors who provide the rationale for government regulation of securities markets.
However, since the $1 million figure includes the value of an individual’s residence,
rising home prices have lifted many who are not necessarily expert in financial
matters over the “accredited” threshold. A decade ago, most hedge funds required
a minimum investment of $200,000 or more, beyond the reach of most households
whose assets were concentrated in their homes. As a result of competition and the
growing number of hedge funds, however, there are now funds that will accept
amounts as low as $20,000. At the same time, pension funds, foundations, and other
institutional investors are placing more and more of their money in hedge funds,
which means that rank-and-file workers, retirees, and others may be unwittingly
exposed to hedge funds losses. The Securities and Exchange Commission (SEC) has
cited this “retailization” of hedge funds as a reason to impose some form of
disclosure requirements on the funds or their managers.3
Systemic risk and investor protection concerns make hedge fund failure a
subject of regulatory and legislative interest. Table 1 below provides basic
information about the most prominent hedge fund failures since the LTCM episode.
The list is not comprehensive: many funds fail each year without attracting much
notice. Since the list has been generated by searching periodical literature databases
(principally ProQuest, Nexis, and Factiva), the cases included have been newsworthy
for one reason or another — generally because of their size, the amount of investor
losses, the risky or exotic trading strategies employed, or because fraud was involved.
2 This was the case with LTCM. The fund was able to borrow extensively and on very
favorable terms in part because the lenders wanted information about LTCM’s strategy,
which was directed by Nobel prizewinners and executed by Wall Street legends.
3 In testimony before Senate Committee on Banking, Housing, and Urban Affairs on
February 5, 2003, in response to a question from Senator Corzine, SEC Chairman
Donaldson described the retailization of hedge funds as “a distressing move” that raised the
possibility that “less sophisticated investors” might not understand the inherent risks. See
also Implications of the Growth of Hedge Funds, SEC Staff Study, Sept. 2003, pp. 80-82.

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CRS-3
Why Hedge Funds Fail
Although some employ very conservative investment strategies, hedge funds can
generally be characterized as high-risk, high-return operations. Pursuit of risk
implies a high failure rate: various studies have estimated that from 7% to 10% of
hedge funds fail each year.4 Since estimates of the number of hedge funds range
from 7,000 to 9,000, this suggests that several hundred funds cease operations each
year.
A recent study5 distinguishes between three reasons for hedge fund failure:
! financial issues, or losses stemming from unfavorable market
moves;
! operational issues, such as errors in trade processing or mispricing
complex, opaque financial instruments; and
! fraud, or misbehavior by fund management.
The most common cause is undoubtedly the first. When hedge funds fail to earn
the hoped-for returns, they are generally unable to attract new investors and managers
find it unprofitable to continue. The normal course is to dissolve the fund, in
accordance with the partnership agreement, and return funds to investors. In many
cases, investors suffer no loss at all (other than the opportunity cost of their failure
to select a more profitable fund), and the end of the hedge fund receives no public
notice. Such failures are not captured in the table below.
When financial losses to hedge funds are sudden or severe, investors are likely
to suffer major losses, and the event is more likely to be reported in the press.
Several such cases are listed below. It is noteworthy, however, that none of the post-
LTCM failures has appeared to pose a risk to the financial system. Nor have there
been waves of hedge fund failures stemming from major market movements, such
as the bear market in stocks of 2000-2002, the subsequent sharp fall in interest rates,
or the energy price volatility that followed the invasion of Iraq.
The incidence of failure as a result of operational issues is probably much lower,
but is difficult to judge because hedge funds disclose so little information about
themselves. Operational concerns have been addressed by regulators, however. In
October 2005, the Federal Reserve Bank of New York convened a meeting of 14
major credit derivatives dealers to address back-office problems and to set goals to
4 See, e.g., Naohiko Babo and Hiromichi Goko, Survival Analysis of Hedge Funds, Bank of
Japan Working Paper 06-E-06, March 2006, p. 30, and Nicholas Chan, Mila Getmansky,
Shane Haas, and Andrew Lo, Systemic Risk and Hedge Funds, prepared for the NBER
Conference on the Risks of Financial Institutions, August 2005, p. 51.
5 Constantin Christory, Stephane Daul, and Jean-Rene Giraud, “Quantification of Hedge
Fund Default Risk,” Journal of Alternative Investments, fall 2006, pp. 71-86.

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CRS-4
reduce the backlog of unprocessed trades in that market, where hedge funds play a
significant role.6
Where fraud is involved in a hedge fund failure, legal and regulatory actions
ensure that an unusual amount of information is made public about the fund and the
circumstances of the failure.7 Thus, cases of fraud are likely to be over-represented
in any tabulation of failures. While the SEC has noted many times that the lack of
disclosure makes hedge fund fraud a potentially serious problem,8 there is no
consensus as to whether actual fraud is more common among hedge funds than other
types of investment.
Limited information is available about the relative frequency of these three
reasons for failure. Christory, Daul, and Giraud categorize 109 cases of hedge fund
default between 1994 and 2005, and find that 54% involved fraud, 33% involved
financial issues, and 13% involved operational issues.9 Sometimes the categories
may overlap: some cases of fraud begin with financial losses which fund managers
fail to disclose.
6 “Statement Regarding Developments in the Credit Derivatives Market,” Federal Reserve
Bank of New York Press Release, Oct. 5, 2005. A year later, the Fed reported that
considerable progress had been made: “Statement Regarding Progress in Credit Derivatives
Markets,” Federal Reserve Bank of New York Press Release, Sept. 27, 2006.
7 Regulators and prosecutors’ version of events is, of course, often disputed.
8 Implications of the Growth of Hedge Funds, SEC Staff Study, Sept. 2003, p. 76.
9 Christory, Daul, and Giraud, “Quantification of hedge Fund Default Risk,” p. 76. The
authors define default as “a loss large enough to prevent the manager from pursuing his
strategy with his existing investors (resulting in investors exiting the fund at a significant
loss),” as opposed to “dissolutions,” where funds return all money to investors because of
poor performance. Ibid., p. 72.

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CRS-5
Table 1. Selected Hedge Fund Failures and Losses Since Long-Term Capital Management
Fund Name (Principal)
Date
Description of Failure or Loss
Sources
Amaranth Advisors LLC
9/06
Ill-timed speculation in natural gas prices;
Futures, 11/06; Wall Street Journal,
(Brian Hunter and Nicholas Maounis)
investors lost about $6.4 billion from the
10/28/06; The Globe and Mail
fund’s peak value of $9 billion.
(Canada), 9/23/06.
Archeus Capital
9/06
Started in 2003 by bond traders from
New York Times, 10/31/06;
(Gary K. Kilberg and Peter G. Hirsch)
Salomon Brothers, Archeus’s assets grew to
MarketWatch, 10/30/06;
$3 billion by 2005. By September 2006,
New York Times, 10/05/06.
assets had shrunk to about $682 million, and
the fund announced it would close by the
end of 2006.
Latitude Fund
8/06
Swedish global macro fund closed after
Daily Telegraph, 10/28/06;
(Brummer and Partners)
losing 27% of its capital in 13 months.
Powerswings
[http://www.powerswings.com],
9/14/06.
Mother Rock LP
8/06
Energy fund fell victim to natural gas price
Futures, 11/06; Barron’s, 8/07/06.
(Robert “Bo” Collins)
volatility — lost $230 million in June and
July 2006.
International Management Associates LLC
2/06
Founder fled after $150 million in investor
The Atlanta Journal-Constitution,
(Kirk Wright)
assets were discovered missing; arrested in
10/26/06, 7/14/06, 2/23/06; Daily
May 2006, Wright faces trial on various
Deal/The Deal, 7/10/06; Los Angeles
counts of mail and securities fraud.
Times, 3/14/06.

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CRS-6
Fund Name (Principal)
Date
Description of Failure or Loss
Sources
Wood River Partners
10/05
Fund was placed in receivership, and the
Forbes, 12/12/05; Financial Times,
(John H. Whittier)
SEC brought civil fraud charges, in October
10/14/05; Wall Street Journal,
2005. Wood River had invested 65% of its
10/12/05.
assets, about $265 million, in a single
telecommunications stock, Endwave, whose
value plunged in 2005.
Bayou Management
9/05
The fund’s founder, Israel , and its finance
Forbes, 12/12/05; Futures, 11/06,
(Samuel Israel III and Daniel E. Marino)
chief, Marino, pleaded guilty to fraud and
10/06; U.S. Fed News, 9/29/06.
conspiracy charges in September 2005,
admitting to using fake results and
accounting to hide trading losses. Investor
losses reportedly about $350-$400 million.
Philadelphia Alternative Asset Management
7/05
Fund was shut down by the Commodity
Washington Post, 10/19/05;
(Paul M. Eustace)
Futures Trading Commission (CFTC) amid
The Guardian (UK), 10/10/05;
charges of trading improprieties which
Barron’s, 7/25/05;Wall Street
involved Man Group, a large UK hedge fund
Journal, 7/06/05.
that executed trades for Philadelphia. Assets
were $320 at the peak; investor losses
estimated at $175 million.
Bailey Coates Asset Management LLP
6/05
This stock fund incurred losses of nearly
Investment News, 8/22/05; Financial
(Jonathan Bailey and Stephen Coates)
25% in 2005, and ceased operations after
News, 7/31/05; Asian Wall Street
promising to return about $500 million to
Journal, 6/22/05.
investors. At its peak, the fund held about
$1.3 billion.

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CRS-7
Fund Name (Principal)
Date
Description of Failure or Loss
Sources
Marin Capital
6/05
This bond arbitrage fund had $1.7 billion in
Wall Street Journal, 8/31/05,

capital at its peak. It closed after sharp
6/16/05.
losses triggered by the downgrading of
General Motors to junk bond status.
Investor losses were not disclosed; fund
promised to return losses to investors.
Aman Capital Global
4/05
This Singapore fund was closed after losing
Financial Times, 4/04/06;
(Mayur Ghelani and Rahul Kumar)
derivatives trades cost it 18% of its $200
The Edge Singapore, 6/27/05.
million capital.
Lyceum Capital
2/05
Technology stock fund closed after 28
Wall Street Journal, 6/16/05,
(John Muresianu)
months of operation, having earned
2/10/05.
minuscule returns on investors’ $112
million capital.
Sterling Watters Group
6/04
The fund made “over-under” (long — short)
Institutional Investor, 2/15/06, 8/05
(Angelo Haligiannis)
stock investments, and claimed to have had
$180 million under management.
Haligiannias was arrested and charged with
running a Ponzi scheme, but subsequently
went into hiding.
Lancer Offshore Fund
5/03
SEC charged Lauer with fraud and
Forbes, 12/26/05; HedgeWorld
(Michael Lauer)
manipulation related to investment in small-
News, 1/06/06; National Post,
cap technology stocks. Investor losses
5/28/03.
estimated at $500 million.

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CRS-8
Fund Name (Principal)
Date
Description of Failure or Loss
Sources
Eifuku Master Trust
1/03
Founded in 2000, Eifuku had $300 million
Wall Street Journal, 4/10/03.
(John Koonmen)
assets at its peak, invested in various
Japanese stocks. During 3 weeks in January
2003, the fund lost 98% of its capital.
Beacon Hill Asset Management
11/02
This “market neutral” stock fund was shut
Derivatives Litigation Reporter,
(John D. Barry)
down by the SEC, which brought fraud
11/12/06; Los Angeles Times,
charges based on trading improprieties.
10/29/04; Institutional Investor, 2/03.
Charges against Barry and other principals
were settled in 2004. Investor losses
estimated at $300 million.
Klesch European Distressed Fund
9/02
Bond “vulture” fund lost money trading
Global Finance, 10/02;
(Gary Klesch)
WorldCom debt. When closed, the fund
The Times, 9/10/02; Reuters, 9/9/02.
(which had aimed to raise $100 million
when it was launched in March 2001) had
only $15 million in capital.
Lipper Convertibles LP
2/02
Bond arbitrage fund was liquidated after
Business Week, 12/9/02;
(Kenneth Lipper)
losing 40% of its value, or about $315
Pensions & Investments, 8/19/02.
million, in 2001. Fund’s capital was
reportedly $2.85 billion at its peak, much of
it contributed by Hollywood celebrities.
Maricopa Investment Fund
10/01
Founder was sentenced to 17 years in prison
Barron’s, 5/30/05; Business Week,
(David Mobley )
and ordered to repay $76 million to
5/26/03; Derivatives Litigation
defrauded investors.
Reporter, 6/2/02.

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CRS-9
Fund Name (Principal)
Date
Description of Failure or Loss
Sources
Tiger Management
3/00
Once the world’s largest hedge fund, with
Institutional Investor, 12/1/02;
(Julian Robertson)
capital of $22 billion, Tiger closed after
Wall Street Journal, 3/30/00.
losses stemming from the tech stock crash.
Quantum Fund
3/00
Fund lost 11% of its capital in five days
Wall Street Journal, 5/22/00.
(George Soros)
when the tech-stock bubble burst. By May
2000, losses were 22%. Quantum Fund was
subsequently renamed Quantum Endowment
Fund and abandoned high-risk strategies.
Manhattan Investment Fund
1/00
In January 2000, the SEC brought charges of
Newsday, 9/2/06;
(Michael Berger)
fraud against this fund, which sold Internet
Wall Street Journal, 1/19/00.
stocks short during the boom. In 2003,
Berger failed to appear for sentencing after
pleading guilty to criminal charges, and
remains a fugitive. Investor losses
estimated at $575 million.
Sources: All sources accessed via Factiva, LexisNexis, or ProQuest databases in October, November, and December 2006.

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