How Not to Start a Hedge Fund

Before the credit crisis this summer, humorist Andy Borowitz wrote about how easy it is to start a hedge fund with just three things: a desk, a telephone, and $10 billion. He offered advice on how to raise the money, how to run the hedge fund, and how to overpay for Manhattan real estate.

It seems that a couple of New Yorkers found out that Borowitz wasn't too far from the truth. According to the U.S. Attorney in the Eastern District of New York, David Lagone and Kenneth Lampasona started a hedge fund with a desk, an online brokerage account, and $500,000.

But they didn't end up with Borowitz's fairy tale ending.

Earlier this week, the F.B.I. arrested the two men for defrauding investors by misrepresenting themselves as Wall Street analysts with a promising trading strategy and a growing hedge fund. As part of their Ponzi scheme, federal agents allege, the two men promised to double investors' money within one year. They raised $500,000 in capital between July 2004 and November 2005, and they managed to lose $450,000 of it during the same period.

According to a Newsday report, Lagone ran the operation out of the photo studio he owns in Plainview, New York. His cohort, Lampasona, was a cashier in a liquor store, and they used an online brokerage account at Interactive Brokers. According to the complaints, when they claimed to investors they had $450,000 in assets in October 2004, the brokerage account actually had a measly balance of $4.60.

Lagone and Lampasona may have fallen a few dollars short of Borowitz's recommended $10 billion. But the case illustrates the power of the words "hedge fund" to unwitting investors in today's market. As long as vulnerable investors exist, Ponzi schemes will continue to serve them.

According to Borowitz, when you've grown bored of your hedge fund, moving on is simple enough. You only need three things to execute your departure: a single-engine plane, $20 million in small bills, and a face transplant.

It seems that the exit strategy is a bit harder to execute than Borowitz made it seem, even with access to all of the liquor you might need to numb the pain from your face surgery.

by Megan Barnett