high returns but also the prospect of huge losses. Hedge fund managers often make risky investment decisions, such as trading options, buying on credit, or practicing arbitrage — simultaneously buying and selling the same security in different markets to take advantage of short-term price differences.
Lay wasn’t the only money manager expecting long-term rates to rise. The Federal Reserve had raised short-term interest rates, believing the move would cause rates across the board to drift higher. But foreign buying of U.S. treasuries and mortgage securities sparked demand for long-term bonds and kept rates low. Muted inflation expectations and other factors also suppressed long-term rates.
Though the loss occurred in 2004, it didn’t become public knowledge until the spring of 2005, when Tom Noe, a Toledo coin dealer who was in charge of a $55 million coin investment fund set up by the BWC, reported that between $10 million and $13 million of the fund’s assets were missing. The subsequent investigation into BWC’s investments placed a spotlight on MDL’s hedge fund performance.
Lay claims the lawsuit is a case of politicking, noting that Ohio Attorney General James Petro, who brought the complaint, has gubernatorial ambitions. Similar to New York Attorney General Eliot Spitzer, Petro is campaigning as an official that will protect public dollars. Sources say Petro, a Republican, initiated the investigation of Noe, a GOP fundraiser, as a demonstration that he would not engage in partisan politics when it came to acts of financial malfeasance. Petro’s office declined to comment on any aspect of the case.
According to Lay, the BWC’s investment staff fully understood and approved his firm’s actions. “They knew exactly what was going on, says Barry Slotnick, Lay’s attorney. “They received reports at a minimum every 30 days and anyone who knows how to read a financial report can clearly see that there was leveraging going on. They were the only shareholder in the fund. So these allegations are just foolish.”
The hedge fund’s board issued a memorandum to the BWC on Aug. 11, 2004, according to the complaint, stating, among other matters, that leveraging “has and will continue to be significantly higher than 150%.” BWC officials maintain that they did not sign the memorandum or approve MDL’s increased leveraging activity.
The BWC initially invested $55 million with MDL in 1998. Lay says his firm has been one of the state’s top-performing, minority fixed-income money managers “and, because of that, they gave us an additional allocation of $100 million. We continued to perform well, and they gave us another $200 million.”
Court documents confirm that “because MDL Capital’s performance with the Bureau’s investment yielded an average annual return through September 2003 of 6.85% [mirroring the Lehman Government Credit Bond Index, the benchmark for this asset class], the Bureau subsequently provided an additional $300 million for MDL Capital to manage.”
Lay says his firm continued to manage money for the BWC for nine months after the $215 million loss, which he believes lends credence to his argument that the lawsuit is a case of political finger-pointing