Blogging Ponzis

The world first found out that Stanford International Bank was a Ponzi when Alex Dalmady went public with his accusations. When I first blogged those accusations, I kicked off my post like this:

Ray Pellecchia and I think that if Harry Markopolos had put his theories about Bernie Madoff online, Madoff would not have been able to continue his scam much longer.

I fully expected then -- and I still expect now -- that many more Ponzis will be uncovered online, rather than through SEC investigations or through the use of old-fashioned journalistic shoe-leather. (That's one reason why I'm disappointed that the list of fellows attending a big workshop next month on reporting financial crime includes not a single blogger.)

The latest red flags in the fund-management industry have been raised by John Hempton, who's suspicious about the reported returns of a fund named Ponta Negra, and who has uncovered at least one fraudulent hedge fund in the recent past. Hempton doesn't use the name Ponta Negra, but it takes only a few seconds of Googling to find the investor letter he's working from.

Ponta Negra isn't a very big fund -- it had about $120 million under management as of the end of February -- but its returns are suspciously high and constant, and it hasn't had a down month ever. The fund also has an unusually expensive 2.5%-and-25% fee structure, which might help in terms of persuading people that it's some kind of exclusive club.

Hempton also claims that the letter he was looking at names "no stated auditor and no stated third party custodian" -- but that doesn't mean they don't exist. When I phoned Ponta Negra to find out more, they said that their returns have been audited by Kahan Steiger, and that they're in the process of moving to a bigger shop, Rothstein Kass. They also told me that their administrator is SS&C Technologies.

Ponta Negra tells me that the firm was founded in 2007, with $7 million under management. They manage three separate funds: the onshore fund, a brand-new offshore fund, and a separately managed account with about $50 million in it. They say that the 2007 returns for the onshore fund were audited by Kahan Steiger, and that Kahan Steiger is nearly finished auditing the onshore fund's 2008 returns as well. The offshore fund will be audited from day one by Rothstein Kass, and Ponta Negra are thinking of asking Rothstein Kass to have a look at the 2008 returns of the onshore fund as well, in order to reassure another big potential investor.

As for the no-down-months thing, Ponta Negra basically just say that they were lucky: they've been down as much as 1% at some points, but have always managed to recover those losses by month-end.

Ponta Negra is well lawyered up: I received a phone call from Doug Hirsch at Sadis Goldberg telling me that he was of counsel for the fund and that he was unaware of any investigations or complaints about them. He told me that he was going to get in touch with Hempton and ask him to take down his posts, along with the comments associated with them. If Hempton refused, said Hirsch, then he would sue him for defamation.

I think it might be a stretch to prove defamation on the basis of Hempton's blog entry, which is careful to raise questions rather than to make an outright assertion that Ponta Negra is a Ponzi. Besides, Hempton is in Australia, which would necessarily complicate any litigation enormously.

But what's clear is that there's a growing tension in the hedge-fund world. On the one hand, any blogger can start throwing around assertions in public -- assertions which can be extremely damaging to a hedge fund. On the other hand, hedge funds are bound by all manner of regulations which prevent them from talking about themselves or publicizing their marketing materials -- regulations which, in this case, mean that I'm not allowed to see the audited reports of the fund to help me decide for myself if there might be something fishy going on.

In other words, hedge funds are at a disadvantage: they're open to public attack, but they're not really allowed to defend themselves in public. I know, your heart bleeds, right?

I have no idea whether there's anything funny going on at Ponta Negra or not, and there's no easy way to find out. This is certainly a long way from being a clear-cut case: no one could read Markopolos's report on Madoff or Dalmady's report on Stanford and not be convinced that they were frauds. Hempton's blog entry, by contrast, is much less compelling.

Still, Hempton's blog is out there now, and all the nastygrams in the world can't squeeze that particular toothpaste back into the tube. So Ponta Negra has to respond somehow: it just has to be very careful about how it does so. I've been in touch with them all day, and they've made it clear that if I publish their name, they'll consider defamation proceedings against me, too. I don't like being threatened like that, but I might think about doing the same thing, were I in their shoes: because they can't respond in public, they're finding themselves forced into making threats.

The real lesson of this whole story, then, is not really about Ponta Negra but rather about the regulatory culture of secrecy surrounding hedge funds. If we let them talk about themselves in public, then maybe these kind of discussions will be much more constructive and much less fraught with legal peril.