Hedge Fund Fraud Case Study — Scoop

Source: Herald Tribune (Arthur Nadel, second from the left)

Abstract:

On January 14, 2009, Peg Nadel reported the police that her husband, Arthur, who managed $350 mm hedge fund operation called Scoop, disappeared after leaving what seemed to be a suicide note in which he apologized for losing his clients’ money. The most shocking about this case was the fact that Scoop’s investors never insisted the manager to have an external audit for nearly a decade of the operations. All investors in Scoop failed this simple and the most important check…

Case Profile:

Background:

“The dust still has not settled in this turbulent market, however the sky seems to be clearing a little. As we stated in last months (sic) letter, October could be considered one of the worst months in market history… We are very proud to report that during this extremely turbulent time our focus on active daily trading brought our funds a return for November slightly greater than ½ of a percent. Our philosophy of active management with discipline has allowed our investors the ability to avoid losses during one of the greatest declines in market history. Someone once said that your strengths are only shown when one is tested.” (Source: Valhalla’s Monthly Report, December 10, 2008)

It appeared that the bottom fell out of the stock markets, however, Neil Moody didn’t care much. On his December 10, 2008 letter, he repeated his usual statements: Not only is your money safe, but generating profits. His partner, Arthur Nadel, was a trading genius whose short-term investment strategy generated almost 28% annualized return, or 1060%, since 1999.

When Neil met Arthur for the first time, he was running “Inside Scoop”, a small investment club at the 1668 Main St office, while playing piano at a falling dinner theater and driving a $4,000 car he’d bought from his divorce lawyer. The returns generated by Arthur’s black box trading program called Microstar was too good to miss for Neil, a former Paine Webber stock broker, who moved from New York to Sarasota, Fl. Neil established Valhalla, a hedge fund, and convinced both Arthur and Arthur’s investors to invest so that the pair can make a big money through 2% management and 25% incentive fees over the S&P 500 Index hurdle.

From the very beginning, Arthur’s investment strategy generated spectacular returns and investors poured their money not to miss this great opportunity. Arthur and his wife, Peg, were major contributors to local causes and charities, including the Diocese of Venice, Habitat for Humanity, the Sarasota Opera Association. Many of his acquaintance through these activities became major supporters of Arthur’s investment program and, by late 2008, Scoop managed almost $400 mm through six different fund vehicles.

Scoop Track Record by Year

Source: Nadel Receivership

Problems:

On January 14, 2009, Peg Nadel, Arthur’s wife, reported him missing after leaving what was termed a suicide note in which he apologized for losing his clients’ money. However, it was immediately suspected that Arthur was alive and on the run. After Arthur went missing, Neil sent investors a shocking letter stating:

“Unfortunately, just yesterday afternoon we became aware of an extremely serious situation suggesting that the Funds may have virtually no remaining value. Additional, our present understanding is not certain enough to permit us to establish net asset values for the Funds. Accordingly, we have suspended redemptions pending our developing a thorough understanding of the situation.” (Source: Valhalla’s Monthly Report, January 15, 2009)

Investors later learned that Arthur started losing money soon after Neil established Valhalla in 1999 and, to perpetuate this Ponzi scheme, Arthur caused the funds to use capital from new or existing investors to pay original investors “trading gains” as reflected on their false monthly statements. The fake profit distribution and the payout of management fees made the eventual collapse of Scoop’s scheme.

Instead of generating a 1060% return, Scoop lost 99.97% over the ten years of running the funds, or $23 million. The funds also paid both management and incentive fees totaling at least $97 million from 2001 to 2008, benefiting both Neil and Arthur. Including all other miscellaneous expenses and losses, Scoop lost approximately $168 mm and left less than $1 million in the trading and bank accounts while the funds were to pay nearly $50 million for redemption request in January 2009.

Scoop Actual Track Record and Trading P&L

Source: Nadel Receivership

Every dollar raised through the six funds was transferred to a bank account held by Wachovia Bank, then to a trading account at Goldman Sachs Execution and Clearing, which only Arthur had a control. Afraid of revealing his losing trades, Arthur threatened to stop providing investment advice when Neil insisted on auditing the funds. Surprisingly, over the 10 years of operating the investment scheme, there was no evidence that any external audit was conducted.

Scoop Organizational Chart

Source: The Importance of Being Diligent

On January 27, 2009, Arthur turned himself in to authorities to face federal securities and wire fraud charges. While serving his 14-year prison sentence, Arthur died at the Butner Federal Correctional Complex in North Carolina on April 16, 2012. He was 79. In a 2011 statement to the Herald-Tribune, Arthur said he never set out to commit crimes.

“I did not plan a Ponzi scheme. At the age of 70 and in poor health, I would hardly have any expectation that I would become the head of a multi-million dollar operation, and even less that it would take a crime to achieve it.”

Goldman agreed to pay $9.8 million in February 2012 and Shoreline Trading paid $2.5 million. According to the receiver, Goldman and Shoreline Trading had no knowledge of Scoop’s scheme but they may have failed to respond appropriately to “red flags” that, if investigated, could have revealed fraud. Holland & Knight also agreed to pay $25 million for its involvement with Arthur. As of April 2014, the receiver recovered and distributed roughly $60 million, or 34% of the total losses.

Recommendations:

Never invest in an unaudited fund

• All investors in Scoop failed this simple and the most important check; therefore nobody should feel sympathy with those who lose money.
• It is still surprising that Arthur has been able to resist hiring an external accountant to audit the funds for over a decade.

Be alert to unusual big positive return

• From 1999 to 2008, Arthur consistently generated outstanding returns despite he has no relevant investment experiences in the past. Such a consistent outperformance is not only unusual, but also nearly impossible for Arthur’s stated investment strategy.

Conduct background check

• The SEC’s compliant and other media reported that Arthur was disbarred as a lawyer in New York on a 1978 incident in which he took $50,000 out of an escrow account to pay off a loan shark.

Check the internal control of the fund and its disciplines

• CarbonBased Consulting, a New York-based consulting firm, published a 16-page report in 2003, which highlighted a number of operational shortcomings such that Scoop’s daily trading activity was reconciled only once a month and the firm didn’t have a clear idea of the assets it held in each fund. Neither the accounting nor the performance of the funds could be certified for accuracy. Scoop also had virtually no policies controlling how it spent money. Checks needed only Arthur’s signature to be cashed. The firm also recommended that Scoop hire a nationally recognized accounting firm and enter into a relationship with a prime broker.
• It is not clear if a prospective investor had an access to this report, however, the existence of the review indicated that investors could have done a similar due diligence on Scoop’s operations.

Always check the operation of the funds and ask for the proof of the performance even you are investing in someone you know

• Don’t feel embarrassed to check someone you know and ask them to give operation and performance proof. Trust, but verify.

Source:

Court Documents

• SEC v. Arthur Nadel, et al., January 21, 2009, http://www.sec.gov/litigation/litreleases/2009/lr20858.htm
• SEC v. Neil Moody and Christopher Moody, January 11, 2010, http://www.sec.gov/litigation/litreleases/2010/lr21372.htm

From Receiver

• Nadel Receivership, http://www.nadelreceivership.com

Other Documents

• “What was the role of Nadel’s partners?”, Herald-Tribune, January 17, 2010, http://www.heraldtribune.com/Arthuricle/20100117/Arthuricle/1171084
• “Eyes Wide Shut”, Sarasota Magazine, September 1, 2012, http://sarasotamagazine.com/blog/2012/09/01/eyes-wide-shut-2/
• “Nadel was disbarred as lawyer in New York”, Herald-Tribune, January 22, 2009, http://www.heraldtribune.com/Arthuricle/20090122/ARTHURICLE/901220350
• Valhalla’s Monthly Report, December 10, 2008, http://www.heraldtribune.com/assets/pdf/SH19318114.pdf
• Valhalla’s Monthly Report, January 15, 2009, http://www.heraldtribune.com/assets/pdf/SH19319114.pdf