NEW YORK (Fortune) -
Wall Street legend Israel Englander is in settlement talks with the SEC and New York Attorney General Eliot Spitzer that could cost his firm upwards of $100 million, people close to the case say.
Englander's $5 billion hedge fund, Millennium Partners, could be accused of securities fraud and Englander himself could be charged with failure to supervise his traders, these people say.
The government's accusations have to do with the way Millennium traded mutual fund shares between 2000 and 2003 -- trading that allegedly netted the firm hundreds of millions of dollars.
People close to the case say Millennium devoted some $1 billion to its trading strategy, opening up thousands of mutual fund accounts to disguise what the firm was doing. Allegedly the firm even deployed a byzantine trading tactic that involved creating subsidiaries with peculiar names such as Osaykanu LLC ("Oh-Say-Can-You LLC, apparently) to hide its trading.
Contacted by FORTUNE, Millennium spokesman Thomas Daly said: "There was no fraud whatsoever."
The settlement comes about two years after the Securities and Exchange Commission and Spitzer's office had launched an investigation, and after one of the firm's traders had pleaded guilty to criminal charges of securities fraud.
It was around that time, in the fall of 2003, that Englander took the unusual step of calling traders away from their desks in the middle of a hectic day to tell them that Millennium was doing just great.
"Don't pay attention to what you see in the press," Izzy said at the meeting, according to a trader who was present. He assured them that the fund's troubles were under control.
Englander was right about one thing: Millennium was doing great, at least in terms of its numbers. Indeed, it is one of the best-performing hedge funds around, averaging 17 percent a year -- after the nosebleed fees it charges -- since it started in 1989. It even posted double-digit returns through the recent bear market.
Numbers like those have given the 57-year-old Englander an aura of infallibility, which has helped him attract prestigious clients that reportedly include Duke University, the ultra-wealthy Canadian Belzberg family, and the Tisch family, which controls Loews Corp. None would comment for this story.
But the stellar returns also kept investors and employees from asking too many questions.
Millennium, with around $5 billion in assets, is an "odd duck compared to other hedge funds we've looked at," says a private detective who specializes in hedge fund reconnaissance.
For one thing, it consists of a labyrinth of entities with different names. Millennium, which has upwards of 100 traders, has tended to be more of a sophisticated day-trading shop, say experts. "Englander takes traders off the street, gives them a pile of money, and says, 'Here's a chair and computer -- go trade'," says someone familiar with the firm.
Many former employees of Millennium counter that Englander is very serious about running his business. Says Peter Feinberg, a former Millennium trader who now heads institutional equity trading at Oppenheimer & Co.: "Izzy's an absolute straight shooter."
That's certainly the way Englander would like his investors to think of him: an upmarket guy who deploys an overwhelming array of ultra-sophisticated models that would just baffle mere civilians. But to maintain an edge, Millennium adapted an "almost anything-goes" mode, according to some former traders.
Millennium spokesman Daly adamantly denies that.
Poorly performing traders are shown the door at Millennium. But if a trader is performing well, he will get more money to manage.
That's what happened with Steven B. Markovitz, now 43, the trader who pleaded guilty to securities fraud in 2003. He started late-trading mutual funds in 2000, according to the criminal complaint. He made around $40 million over two years. Markovitz relied in part on a trio of brokers at Merrill Lynch to open accounts he used for trading.
Late trading, which is illegal, entails buying fund shares at a stale price after the market closes, which can be valuable if there are late-breaking market developments. Market timing, while not illegal but often forbidden by mutual fund companies, involves frequent trading of fund shares.
Millennium's Daly says there is nothing unusual or illegal about using a variety of names and addresses for different subsidiaries and accounts.
A person familiar with the government's investigation has a different point of view: "Millennium is in trouble for creating entities, opening accounts, buying variable annuities for the sole purpose of deceiving mutual funds. That's securities fraud."
Englander is willing to pay to settle the case and even admit certain indiscretions, says someone familiar with the matter, provided he isn't barred from the industry. He's already set aside a kitty, using mostly his investors' money, to help cover any settlement.
And after the Markovitz scandal broke, he imposed a "gate" that tightens the fund's control over the amount of capital an investor can withdraw in a specified period of time.
Of course, that doesn't mean investors won't eventually run away -- particularly pensions, endowments and charities that might feel particular pressure to withdraw from a fund whose reputation has been impugned.
Meanwhile, an insider says, "there's sheer panic at Millennium right now." It could be that the black box that Izzy built is starting to crack.
Read the full story on Fortune.com.
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