Mark D. Lay is in for the fight of his life. His company, one of the nation’s largest black-owned money managers, has been rocked by a scandal involving one of its hedge funds that lost more than $200 million.
The CEO of MDL Capital Management (No. 6 on the BE ASSET MANAGERS list with $2.82 billion in assets under management) is facing a lawsuit initiated by the Ohio Bureau of Workers’ Compensation (BWC), a state agency that oversees more than $21 billion in assets. The BWC, which had a significant investment in an MDL-managed fund, alleges MDL made unauthorized investment decisions that led to a $215 million loss in November 2004. According to sources, roughly $8 billion of BWC’s $21 billion in assets is invested in fixed-income investments.
Although damages sought by the bureau were not specified, the lawsuit, filed June 10 in the Franklin County Court of Common Pleas, claims MDL, its founder, and six others committed fraud, breach of contract, conspiracy, unjust enrichment, and aiding and abetting. (Black Enterprise/Greenwich Street Corporate Growth fund, which is managed by Earl G. Graves Ltd., parent company of this publication, owns a stake in MDL.)
MDL’s leveraging strategy is one of the main points of contention. “There are two issues. One is that they bet correctly against interest rates — that was, in my understanding, the genesis of the fund in terms of its premise,” explains Jeremy Jackson, a spokesman for the BWC. “The other issue deals with leveraging and whether or not they leveraged the value of the investment beyond what was permitted by the contract.”
According to court documents, MDL’s contract allowed it to leverage, or borrow, up to 150% of BWC’s $225 million investment in the Active Duration Fund, an offshore hedge fund based in Bermuda. As the fund manager, MDL engaged in such transactions as a means of capitalizing on shifting market conditions. However, the BWC charges that, at one point, MDL leveraged more than 1,900% of the fund’s total assets.
Compounding the high leveraging, the fund manager incorrectly predicted that long-term interest rates would begin to rise from their current lows as the economy began building momentum. MDL borrowed bonds in order to sell them and pay back the lenders at a later date, a practice known as taking a short position or shorting. If interest rates rose and bond values fell (bond valuations and interest rates move in inverse directions), MDL could have replaced the borrowed bonds at a cheaper price. As a result, the fund would generate a profit. But in 2004, long-term rates dropped, and the hedge fund, like many others, lost money. Inside sources say that BWC’s investment staff agreed with Lay’s strategy as it related to interest rates and instructed BWC to continue its investment in the fund.
Hedge funds are private investment vehicles — open only to accredited investors — that are not regulated by the Securities and Exchange Commission. Hedge fund managers, therefore, are bound by fewer restrictions than mutual fund managers. These funds carry the chance of