Hedge Funds In NY Pay-To-Play Probe

Fronting The New York Times’ metro section Sunday morning, news that bold-face hedge fund names—including Daniel Loeb’s Third Point Capital, and former Lazard Frères vice chairman Damon Mezzacappa’s Mezzacappa Management LLC—are implicated in an investigation into whether “the sons and top aides of former state comptroller Alan G. Hevesi improperly reaped benefits from his control of the state’s $154 billion pension fund.”

As comptroller, Hevesi was sole trustee of the fund from his election in 2002 until Dec. 2006 when he resigned, weeks after his re-election, and admitted defrauding the state by having its employees chauffeur his ailing wife. He was fined $5000.

State attorney general Andrew Cuomo, son of the former New York governor Mario, said in May that his office was investigating “very troubling, serious, systemic conflicts of interest” in the fund’s management. Details of the alleged conflicts under scrutiny, according to The Times, and some of NakedShorts’ unsolicited opinions, after the jump:

In 2005, the comptroller’s office decided to invest a portion of the pension’s money in a fund that invests in hedge funds, including Third Point. Several months later, Third Point hired Mr. Hevesi’s elder son, Daniel...A person with knowledge of the investigations said a top official within the comptroller’s office knew about the relationship between Third Point and Daniel Hevesi and circumvented internal guidelines requiring that it be disclosed. [Emphasis added].

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Investigators are also examining the relationship between the elder Mr. Hevesi’s office...and eSpeed (ESPD), a Manhattan-based company that has processed trades for the pension fund. Mr Hevesi’s longtime political consultant, Hank Morris, has served on the board of the company and collected millions of dollars in connection with his role there, a person involved in the investigation said. The payments were said to be “placement fees,” but it was not clear what services Mr Morris had provided to earn them. Such fees are usually paid to marketing advisers who help investors win blocks of pension money to manage.

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[The probe] was set off by allegations that the comptroller’s former chief of staff, Jack Chartier, had obtained, among other things, a loan for his friend, the actress Peggy Lipton, from an executive at Markstone Capital, another firm that manages pension fund money...

...Some of [Hevesi’s younger son, and New York Assemblyman] Andrew Hevesi’s contributors lived thousands of miles from his Assembly district, including Elliott Broidy, the Los Angeles-based chairman of Markstone. He donated $3,400 in 2005.

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Another company that contributed to campaigns by members of the Hevesi family is Mezzacappa Management LLC, a private investment firm based in Manhattan that manages a number of funds for wealthy individuals, pension funds and other institutions. One of its funds, the Mezzacappa Maiden Lane Fund, received $198 million from the New York pension fund in January 2005.

Mezzacappa Management and people tied to it have made donations to Alan Hevesi since 2002 totaling $88,000, according to campaign filings. In 2005, the firm and its chief executive, Damon Mezzacappa, also made contributions totaling $5,000 to Andrew Hevesi.

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• It is legal in New York State for investment managers to make political contributions, although “It would be illegal for companies to make contributions with the understanding they would receive business or favorable treatment, but such a case would probably be difficult for investigators to prove.”
• All those named in the story declined comment.
• The people “involved in the inquiry” have something in common with hedge fund managers: a modest reticence for being quoted by name. The Times did not disclose the reasons for their anonymity, but speculation involving the phrase “were not authorized to speak publicly” would probably be right on the money.

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For NakedShorts’ money ($0.02):

1. The lines between illegal conflicts of interest, actual conflicts of interest and the appearance of interest conflicts are thin, and blurred, and are under increased scrutiny as public pension funds invest ever more heavily in hedge funds, private equity and other ‘alternative investments,’ controversial—rightly or wrongly, fairly or unfairly—for their investment strategies and lucrative fee structures. Get used to it.

2. Even arguably tenuous connections—the state pension fund allocation was to “a fund that invests in hedge funds, including Third Point,” not to Third Point directly—can become targets—rightly or wrongly, fairly or unfairly—for the attention of both investigators and the media. Consider:

• It is at least remotely possible that, when Third Point hired Hevesi, Third Point was unaware that its investor had an allocation from the state pension fund. Funds of hedge funds are only slightly more likely to disclose client names to their constituent funds as to their competitors, and for at least some of the same reasons.
• More possible, the “top official within the comptroller’s office” who allegedly knew about the relationship between Third Point and Daniel Hevesi and, allegedly, circumvented internal disclosure guidelines, made a good faith decision that no conflict existed. For one, the Third Point investment was directed by the fund of hedge funds, which may well have had the manager in its portfolio before winning the NY state pension fund mandate; as well, it is more than likely that the allocation amounted to an immaterial proportion of Third Point’s assets.
• More likely still, Third Point had appropriately self-serving reasons for hiring Daniel Hevesi. His father’s failings had yet to surface in 2005 and the scion of a politically-connected family with a relatively uncommon last name is more likely than most prospective employees to both know who to call, and to get his calls returned [Daniel Hevesi was also a New York state senator until 2002; according to the Albany Times Union, he was not a candidate to replace his father because of “allegations of past drug use”].

3. Despite the Hevesi (Sr) scandal, New York’s perpetually grid-locked legislature has yet to address the obvious concerns of investing so much control over such huge sums in a single largely unaccountable—except quadrennially to the electorate, which in this case returned Hevesi to his post, despite the controversy that led to his resignation—individual.
4. Pay-to-play scandals are a long-standing tradition of the political landscape. And they will be until the most conflicted figures of all, legislators, incumbent and aspiring, decide to change a system that transforms virtually all but the Michael Bloombergs of this world into cynical mendicants at the shrine of deep pockets. Notably, in recent days:

...[efforts to raise tax rates for private equity and hedge fund managers have] divided the Democratic Party’s populists and pragmatists, particularly as the party has courted Wall Street for campaign contributions. Senator Christopher J. Dodd of Connecticut, for instance, the chairman of the Senate Banking Committee, has not taken a position on the proposals. Nor has Senator Charles E. Schumer of New York, the top fund-raiser for the Democrats in the Senate...

Hevesi’s Sons and Aides Face Pension Fund Investigation
by Danny Hakim and Mary Williams Walsh
The New York Times Jul. 15 2007

Clinton Backs Higher Taxes for Investment Firm Managers
By Stephen Labaton
The New York Times Jul. 15 2007