Hedge Fund Fraud Case Study — Westgate


Source: New York Daily News


James Nicholson’s hedge fund dream ended with a diminishing cash balance during the financial crisis. He told his clients that his firm, Westgate Capital, was making money, while others were losing. In fact, he was losing even more.

Case Profile:


James Nicholson had a choppy career. After graduating from the State University of New York at Stony Brook, he joined Shearson Lehman Hutton, Inc. in Oct 1988. Within five months, he switched employers twice, to Drexel, then to Smith Barney, where he spent 2 years and 3 months. Over the next 8 years, he would work at Prudential, Merrill Lynch, First Colonial Securities and The Key Group.

In 1999, Nicholson left The Key Group to establish Westgate Capital Management, LLC (“Westgate”), an unregulated hedge fund management company, in Saddle River, NJ, with Robert Lee, his classmate from SUNY, and began soliciting wealthy individuals to invest in his equity long/short strategy. The performance of Nicholson’s first fund, Westgate Growth Fund, was second to none as it generated consistently strong returns regardless of market conditions.

Nicholson was also a consummate marketer. In December 2008, he solicited investors with a “special” opportunity to earn an 8–10 percent guaranteed return for a one month investment available only to Westgate’s “best clients.” At least one existing investor took advantage of this offer by investing an additional capital with Westgate.

Nicholson’s business seemed to be very successful to prospective investors as he often informed them that Westgate’s AUM was over $750 million. By early 2009, however, he was running into trouble.

Exhibit 7.1: Performance Second to None


In December 2008, a few days after the news of Bernie Madoff’s arrest, Ray Froimowitz, a representative of Carrickmore Property & Development Co., LLC (“Carrickmore”), became suspicious of Westgate and requested that Nicholson provide audited financial statements for their investment in Westgate Strategic. Nicholson agreed to provide the documents immediately, but never did. On December 26, 2008, Froimowitz attempted to physically visit the NY office of Havener and Havener (“Havener”), Westgate’s audit firm since inception — Froimowitz couldn’t believe what he found there. The listed address of Havener, 49 East 41st Street, New York, NY was a small, empty home to a “virtual” office.

Nicholson stopped paying rent and salary as early as January 2009 due to a dwindling cash balance. As the financial crisis deepened and his investors needed to cash out, Nicholson had trouble raising enough money to sustain his big lie. Checks he sent to the investors bounced due to insufficient funds. In February 2009, the FBI arrested Nicholson, while the US Attorney’s Office for the Southern District of New York announced criminal charges of Securities Fraud and Bank Fraud against him. It was the end of his game.

Nicholson later admitted that he failed to make money from the beginning. As his losses mounted, he realized it was almost impossible to recoup them. Instead of revealing the truth to his investors, he took money from the hedge funds and spent it on himself. Westgate never managed anywhere close to $750 million, managing a mere $218 million. Westgate lost 35% of capital through trading, 17% through theft and 6% for other reasons.

Exhibit 6.2: Westgate’s Gains and Losses

Source: United States of America v. James Nicholson (2009),
Note: Lee Richards, Receiver of Westgate, later recovered $9.99 million from investors who made “fictious profits” in November 2010


Conduct thorough background checks, including FINRA broker-dealer database and interviews with former employees

  • FINRA BrokerCheck is an important source of background information for managers. Many of them have experiences working at a broker-dealer. According to easily accessible records, Nicholson was sanctioned by NASD (now FINRA) and barred in all capacities as a broker-leader in 2001 for (1) furnishing the NASD with a false/misleading response to a request for information and (2) failing to respond to NASD requests for information made pursuant to NASD rule 8210.

Exhibit 7.3: Red Flag on the FINRA’s BrokerCheck Result

  • According to an article published and accessible on NorthJersey.com, at Prudential Securities in Fort Lee and Merrill Lynch in Bardonia, N.Y., Nicholson faced customer complaints of “unsuitable trading” or “unauthorized trading.” Nicholson had a more serious problem in 1995 when he was fired from Merrill Lynch after he admitted to management that he “exercised discretion” in client’s account — and act that violated firm policy.
  • A number of customers from Nicholson’s time at First Colonial accused him of embezzling money from their accounts, according to the securities records. Nicholson left the firm in March 1999 and got a job at The Key Group Inc., an investment firm in Ramsey. There, he came under internal review for apparent wire transfers from a customer’s account into his personal bank account, according to securities records.

Review legitimacy of an audit firm

  • It is always advisable that potential and existing investors review the capability and stature of an audit firm.
  • In case of Westgate, Nicholson fabricated an entire firm — Havener and Havener — in order to hide losses from his hedge funds. This is very similar to what Sam Israel of Bayou did.
  • Havener and Havener was never known as an audit firm and prospective investors should have been concerned with its legitimacy when they saw the name. Cold call an audit firm to ensure that they have more than one employee. For a purported $750 million hedge fund account, an annual audit cannot be handled by only one person. Check if the accountant really possess a CPA designation via the Office of the Professions website (for NY), http://www.op.nysed.gov/opsearches.htm

Exhibit 7.4: Verification Search for NY CPA

Review Form 13F on the SEC’s EDGAR system

  • All institutional investors that use the U.S. Mail and exercises investment discretion over $100 million or more in Section 13(f) securities (publicly traded US stocks, equity options and warrants, ETF and convertible bonds) are required to report its holdings on Form 13F with the SEC. Form 13F is available for public through the SEC’s EDGAR System (http://www.sec.gov/edgar/searchedgar/companysearch.html)
  • Although Westgate claimed that it traded U.S. stocks with over $750 million in assets under management, it had never filed a Form 13F. This is clearly a serious warning sign for either (1) violation of the Securities Exchange Act or (2) the manager does not exercise investment discretion over $100 million.

Use your common sense…

  • Westgate’s investment performance was simply too good and too consistent. Exhibit 5 shows that the performance of Westgate is almost a flat line with two extremely sharp growth periods. This unreasonably consistent return profile is similar to other well-known fraud cases like Madoff and Petters (Exhibit 6.5).

Exhibit 6.5: Comparison of Returns Since Inception

Source: US v. James Nicholson, et al (2009), HFRI


What can be salvaged?”, NorthJersey.com, September 13, 2009

’Huge holes’ in oversight, NorthJersey.com, August 16, 2009

U.S. Securities and Exchange Commission v. James M. Nicholson, et al (2009), United States District Court Southern District of New York

Carrickmore Property & Development Co., LLC, a Delaware limited liability company, On Its Own Behalf and On Behalf Of All Others Similarly Situated v. James M. Nicholson, et al (2009), United States District Court Southern District of New York

United States of America v. JamesNicholson (2009), United States District Court Southern District of New York



Shinya Deguchi @ Star Magnolia Capital

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