MORE ON BAYOU • Bayou funds founders plead guilty • DOJ seeks $101M from Bayou • Suicide note deepens Bayou probe

NEW YORK (CNN/Money) - Investors in Bayou Group, whose top executives pleaded guilty to orchestrating a $450 million fraud Thursday, are undoubtedly wondering how they could've gotten sucked in by the Connecticut hedge fund shop.

Founder Samuel Israel III and CFO Daniel Marino pleaded guilty to charges that they raised more than $450 million from investors, lied to them about the fund's returns and formed a phony accounting firm to audit the firm's results. State officials in Arizona had seized $100 million in funds believed to belong to Bayou's investors, according to court documents. (Full story).

Typically, when authorities uncover hedge fund fraud, the investors turn out to be individuals who often don't have the tools they need to weed out underperforming or potentially criminal managers.

But what's interesting about Bayou, particularly when compared to other famous hedge fund blowups, is that a handful of big investors got burned, including some funds that invest in hedge funds on behalf of clients, so-called funds of funds.

In fact, some money managers say that one benefit of investing in funds of funds is that the fund manager does extensive research, including background checks, on each hedge fund manager.

Big investors such as banks, university endowments or pension plans usually have the means to conduct such research on their own.

"People invested with (Israel) because he had a Wall Street pedigree and had worked with people at hedge funds who seemed to think he was bright, and a good trader," said Doug Hirsch, an attorney with the law firm Sadis & Goldberg who is representing a Bayou investor. "People said, 'I know that guy, he's good, his family's wealthy and he knows a lot of people'."

Randy Shain, co-founder of the investigative firm First Advantage CoreFacts, said his firm investigated Bayou on behalf of clients who were considering investing in it. The firm, formerly known as BackTrack Reports, first looked into Bayou in 2001.

"I always thought this was a person I wouldn't do business with (but) I wouldn't have thought he was a total crook," he said, noting, though, that there were red flags in Israel's background.

"The trick here is you had a guy who was purportedly producing these nice returns. The accounting thing is hard to overlook," he said, referring to the creation of the bogus accounting firm. Most institutional investors demand audited returns from hedge funds and look for a well-known auditor's name on the work.

Shain said after his firm's investigation of Israel and Bayou, "we ended up with more questions than answers." Israel's resume was filled with platitudes and generalities about years of trading but was short on specifics, according to Shain.

And a little legwork revealed that Israel often exaggerated his experience -- including claiming to be a head trader at respected hedge fund Omega Advisors when in reality he held more of an administrative role, according to Shain. Israel also exaggerated how long he worked at Omega, he said.

While the fraud was allegedly taking place, the firm's founders were living the high life, according to reports.

Israel rented a 10-bedroom mansion, originally built for ketchup magnate H.J. Heinz, from Donald Trump for $32,000 a month, while Marino began driving a Bentley and ditched his Staten Island digs for a multi-million home in Westport, Conn., according to the New York Times.

Meanwhile, the duo were trying to recoup Bayou's mounting losses by investing in private deals in the United States and abroad -- transactions which turned out to be frauds, according to the U.S. Attorney's office.

In another strange twist in the Bayou case, Marino admitted to years of cooking the books in a would-be suicide note, according to media reports.

Shain said most of Bayou's investors were individuals, possibly seduced by the firm's low minimum investment and lack of a management fee, which is highly unusual for a hedge fund.

But Shain, who has never met Israel, suspects that Israel oozed charm and projected a folksy image -- a common trait among successful hucksters, he said.

"Look at other people who have gotten other people to listen to them -- they have this ability to captivate people with their speech," he said. "You have to have that."

Also, some of Israel's actions probably made some big investors comfortable, by letting them out of the fund when they wanted, for example, and even telling them about a lawsuit filed by a former employee, though he withheld incriminating details, Shain said, adding some investors probably thought such things meant Israel was straightforward.

"One thing he was smart at doing was understanding the psyche of other people who were investing with him," Shain said of Israel.

"I don't know if that's because he's a good crook or (because) he actually cared," Shain said, adding he still wasn't sure whether Israel started with good intentions and only started committing crimes to cover his losses.

Hirsch of Sadis & Goldberg said that investors trying to get their money back will probably sue others involved with the fund, such as prime brokers who settle trades or people who invested in Bayou on behalf of clients.

"Everyone is looking at those counterparties right now as deep pockets and is putting together information in an attempt to bring a claim," said Hirsch. "More likely than not that someone will bring a claim against these parties."

In addition to the criminal charges, Israel and Marino face a raft of civil lawsuits, including a complaint filed by the Jewish Federation of Metropolitan Chicago. The SEC filed its own lawsuit Thursday, seeking civil penalties and for funds to be returned to investors.

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For more on corporate crime, click here.

What's happened to the hedge fund guys accused of swindling millions? More here.

For why hedge funds may be part of a storm brewing on Wall Street, click here.