Is K1 Group Just Another Hedge Fund Fraud?

Includes: BCS, BNPQY, JPM
by: Larry Doyle

Fraud knows no boundaries.

I strongly believe we will see dozens of hedge funds, fund of funds, and other financial frauds revealed over the coming months. In fact, I addressed this likelihood last April in writing, “Low Tide Will Reveal Rats Scurrying Amidst The Garbage”:

Additionally, do not forget that many hedge funds suspended redemptions in the latter half of 2008. Ponzi schemes, like rats, only thrive given a steady source of food and water in the form new investments. Suspending redemptions is akin to a rat rationing its food supply. While plenty of those suspensions could be legitimate, it would be naive to think that all of them are.

What do we learn today?

Breaking news indicates that a German fund of funds, K1 Group, may very well be the next rat exposed by the global market meltdown. A legitimate fund of funds company allocates capital across a wide array of different hedge funds. We certainly know that did not happen with the funds feeding Madoff. What happened with K1 Group?

Initial reports indicate that K1 engaged in circular trading which gave the appearance of K1 managing more capital than it actually did. In the process, K1 was able to use the perceived funds as collateral for bank loans. These banks will likely take significant hits. Who are the banks? Bloomberg reports, K1 Hedge Fund Snared in Probe as Barclays, JP Morgan Face Losses:

K1 Group, the German hedge fund firm, is embroiled in an international criminal investigation after saddling banks, including Barclays Plc, JPMorganChase & Co. and BNP Paribas SA, with about $400 million of losses, people with knowledge of the probe said.

European and U.S. authorities are examining whether K1, which manages funds of hedge funds, deceived the banks when borrowing money to ratchet up the size of its investments, according to the people, who declined to be identified because the investigation isn’t public. German and U.S. prosecutors may announce the first charges in the case as soon as this week, they said. JPMorgan inherited its exposure to K1 after acquiring Bear Stearns Cos., which did business with the fund manager.

The inquiry focuses on whether K1, founded by German psychologist Helmut Kiener, 50, engaged in circular transactions with a network of investment firms in the U.K., the U.S. and other countries to create the illusion that K1 had more money available to backstop loans from the banks, the people said. The K1 Web site says Kiener’s investment system generated an 825 percentreturn from 1996 through last June.

Some comments and questions:

1. Do you think Jamie Dimon is wondering what other exposures he may have inherited from Bear Stearns that have yet to be exposed?

2. Just what exactly was the nature of Bear’s relationship? Did Bear invest in K1? Did Bear merely act as custodian and clearing agent?

3. Who are the firms with which K1 transacted? In ‘following the money,’ how many of those firms are also frauds? This trail will be very interesting.

4. Let’s focus on K1. Who was on the K1 team? The K1 Group management team consists of Mr. Helmut Kiener and . . . and . . . nobody else is listed. MAJOR RED FLAG!!

While Kiener and everybody connected with K1 are presumed innocent and entitled to due process, call me suspicious. Why? Phone calls into K1’s offices were not being answered. Interesting.

As I reviewed the K1 site, there was no depth to the material presented. A high school student with decent web designing skills could have formatted it.

Jamie Dimon must be seething.

Disclosure: No position JPM