BusinessWeek

DECEMBER 9, 2002
COVER STORY

The Fallen Financier

Ken Lipper wanted to be a big wheel in Hollywood and New York. But he may be remembered most for the collapse of his hedge fund empire-and huge losses for the rich and famous

On the morning of Jan. 14, 2002, the Park Avenue offices of Oscar-winning money manager Kenneth Lipper were uncannily quiet. It was 9:30, the start of the trading day, but the fund manager and the research director who ran Lipper & Co.'s $2.8 billion hedge fund, Lipper Convertibles LP, were nowhere to be seen. Their desks, which stood just a few feet from Lipper's own expansive, glass-walled office, were curiously neat. Gone were the usual scribbled notes, crumpled papers, and half-filled coffee cups. A phone emitted a constant, low-pitched buzz. The two men had turned up early that morning, resigned, and left abruptly--without any explanation. Lipper, a former New York deputy mayor, was out of the office too that day, working in Hollywood on a film he was producing and meeting with some of his hedge-fund clients.

Abraham Biderman, executive vice-president at the firm and Lipper's right-hand man, was alarmed. Why had the traders, Edward Strafaci and Michael Visovsky, jumped ship? He knew that Lipper & Co.'s longtime auditor, PricewaterhouseCoopers, was planning its annual audit soon and would be questioning "the boys," as several co-workers called them, about trades they had made. Biderman was also aware that Strafaci and Visovsky had pocketed their annual bonuses just days before. Biderman started to panic. Soon, his worst fears were confirmed:

Strafaci and Visovsky had left behind a trail of unanswered questions about a securities portfolio that was in tatters.

It wasn't until a month later that Lipper dropped the bomb on his investors, many of them his famous and powerful friends from the worlds of entertainment, politics, and Wall Street--such as actor Julia Roberts, Walt Disney (DIS ) CEO Michael D. Eisner, Senator Ernest F. "Fritz" Hollings (D-S.C.), the family of financier Henry Kravis, and publishing and real estate tycoon Mortimer Zuckerman. In a Feb. 20 letter to investors, Lipper disclosed that Lipper Convertibles had lost "in the neighborhood of 40%" of its value, or about $315 million, in 2001, instead of the 7.7% gain the firm had reported near the end of the year. The hit to Lipper's $4 billion empire of money, hedge, and mutual funds was so serious that it would eventually force the 16-year-old firm under.

Lipper & Co. is now liquidating all of its hedge funds and mutual funds. It has also sold its $500 million high-yield-bond business because of the debacle. The firm has acknowledged that it is being investigated by the Securities & Exchange Commission. Sources say that the FBI is also conducting an inquiry. If the government pursues a case, Lipper could be charged with failure to supervise his traders or even with fraud--and if he is found liable, it could cost him his career in the securities industry. If criminal charges are upheld, he could possibly land in jail, say sources close to the SEC probe.

Ken Lipper's fall epitomizes a tumultuous chapter on Wall Street. He was a creature of the times--at home in the "greed is good" precincts of Wall Street and comfortable running with a fast Hollywood and Manhattan crowd. The ruddy-complexioned, fuzzy-haired Lipper may be best known to some as an adviser on Oliver Stone's 1987 movie Wall Street. But he has also carefully crafted the image of a Renaissance man with the Midas touch. Lipper has flitted, almost Zelig-like, through the worlds of investment banking, politics, money management, movie production, philanthropy, and book publishing. In the mid-'80s, he was Edward I. Koch's deputy mayor. In 1999, he even won an Academy Award for The Last Days, a documentary about the Holocaust that he produced with Steven Spielberg.

The flashy pitchman with his fancy connections and wealth was a magnet for investors who never questioned his ability to manage their money. According to one investor: "He would say, `You're investing alongside me and my family."' Recalls another: "I was told repeatedly that the fund was like a `high-powered' savings account." The Hollywood crowd, especially, trusted Lipper, a former partner at both Lehman Brothers Inc. (LEH ) and Salomon Brothers (C ). Says an insider: "These were rich--but largely financially ignorant--people who were wowed by his blue-chip Wall Street credentials."

They should have taken a closer look. Documents obtained by BusinessWeek show that Lipper Convertibles, an arbitrage fund set up to buy the convertible bonds of companies and simultaneously sell their stock short as a hedge, was marketed as a conservative investment. But it held a large number of highly speculative securities and was heavily leveraged. Described in the prospectus as a "market-neutral" fund that aimed to make money whether the stock market rose or fell, it wasn't hedged properly. What's more, although auditors PwC signed off on its accounts, Lipper & Co. had probably been mispricing the fund as far back as 1995, according to an Oct. 3 internal report by accountants BDO Seidman LLP. Nevertheless, Steven Silber, a PwC spokesman, says the firm does not comment on client matters. (Lipper & Co. is not related to the fund research company Lipper Inc., which is part of Reuters Group PLC. (RTRSY ))

Some investors allege that Ken Lipper may have known about the mispricing for months before telling his clients. An affidavit filed by one investor on May 15 in the New York State Supreme Court says that in late 2001 Lipper called him at home in the evening, attempting to persuade him to switch out of the troubled convertible arbitrage fund into a new distressed-securities fund. "In my opinion, it's almost inconceivable that Lipper--who had millions of his own dollars, as well as his family's money, tied up in the fund--didn't know about any of this stuff sooner," says Leslie Akins, a lawyer for one of Lipper's investors. Biderman says Lipper was "absolutely, categorically unaware" of any mispricing prior to Strafaci's and Visovsky's departure and the resulting internal investigation. Lipper had tens of millions of his own money in the funds, say sources.

Lipper, who declined numerous interview requests by BusinessWeek, has maintained his innocence in letters to investors, at first blaming the demise of the fund on market woes and "the extraordinary combined severity of 2001 events." But he also pointed a finger at his traders, Strafaci and Visovsky, saying that their abrupt exit led the firm to conduct its own investigation, which concluded that "a more cautious valuation was warranted." In a follow-up letter on Mar. 26, Lipper told investors the fund had fallen 47% since Dec. 31, 2000.

Some of Lipper's powerful friends support him. Says John H. Gutfreund, former CEO of Salomon and Lipper's boss back in the late '70s: "I don't think I would blame this on Kenny. He had the wrong guys running the fund." Biderman says: "Lipper absolutely, categorically was not aware of any of the fund's problems." However, one investor's lawyer sarcastically labels Lipper's explanations as possibly "another Oscar-worthy performance." And Strafaci rejects Lipper's claims. "We don't bear any responsibility at all," he says. "Clients have to go to Ken Lipper if they're mad--he was the CEO." Visovsky didn't return phone calls.

Many of his investors are furious. At least two--Race Rock Corp., a private investment firm, and Mesorah Heritage Foundation, a Jewish charity--have filed suits in the New York State Supreme Court and the U.S. Bankruptcy Court in the Southern District of New York, respectively. Race Rock's suit, which sought details of the fund's investments, alleged that in the months after the valuation bomb was dropped, the company's strategy was to "delay, evade, conceal, deceive, and finally refuse" to give out information. Lipper & Co. subsequently supplied some of the requested information.

On Oct. 4, Lipper & Co. sent a distribution plan to investors for the liquidation of Lipper Convertibles. Many are hopping mad because, they say, the plan favors those who entered the fund recently over longer-term clients. Investors have filed more than 20 letters of objection to the plan. One of them, according to court filings, is Lipper's ex-wife, Evelyn Gruss, a respected developmental pediatrician who had kept money with Lipper after their divorce in 2000. A hearing in the New York State Supreme Court, originally scheduled for Dec. 5, was postponed until Jan. 7. "You're going to see more lawsuits fly after the hearing," says an insider. "This could ruin Ken Lipper."

Already, Lipper is reeling from personal financial woes. His publishing venture with Viking Books, the Lipper/Viking Penguin Lives Series, in which renowned authors such as Larry McMurtry and Jane Smiley wrote biographies of historical luminaries such as Crazy Horse and Charles Dickens, started to unravel this summer when Lipper stopped funding it. His pal Roger Altman, a former deputy Treasury secretary who now runs an investment banking boutique, later stepped in as a white knight to keep the critically acclaimed project going. Marshlands, Lipper's 30-acre spread in Southampton, N.Y., which he bought for around $9 million after his divorce, was put on the block last summer for $18 million. The house--which Lipper was in the middle of renovating and which has features such as a boat launch underneath allowing direct access to a speedboat--later sold for $10 million.

Next to Lipper's sizable bank accounts, the glitterati he hobnobbed with, such as Spielberg and Robert DeNiro, were his biggest assets. He adroitly used his impressive credentials and fancy connections to attract big money to his firm, some sources say. "His connections were like gold to him," says a longtime friend. Lipper's investors were strictly A-list, too. Sources say that, in addition to Roberts, Eisner, Hollings, and Zuckerman, the roster included Lipper's pal William J. McDonough, chairman of the New York Federal Reserve; actor Danny Aiello; Italy's Agnelli family, of Fiat fame; various entities of the Tisch family, owners of Loews Corp. (LTR ); and some members of the Rothschild banking family. Other than Kravis, who says he withdrew from the fund before the losses occurred, none would comment. A lucky few had invested in Lipper's offshore convertibles fund, which suffered only 10% losses.

Hollywood retirement funds, such as the Motion Picture Industry Pension Plan and the fund for Creative Artists Agency, had at one time invested with Lipper, along with several religious charities and educational institutions, according to marketing materials obtained by BusinessWeek. Trust money for Lipper's four daughters is tied up in the fund, say sources. Ed Koch, a former investor, says he was lucky enough to withdraw his money before Armageddon came. "Clearly, there are people who have suffered large losses. It's all very sad. I'm sure this has hurt Ken personally--his pride as well as his finances," he says.

Critics say they believe Lipper, who pocketed a standard-yet-hefty 20% hedge-fund performance fee, didn't seem sufficiently involved in whether the money was properly invested. "It seems Lipper was basically asleep at the wheel," says a fund-of-funds manager. Others are harsher. Says Michael Ocrant, editor of MarHedge, a hedge-fund newsletter: "Lipper most likely knew these traders were mispricing the portfolio and juicing the returns all along. But he was so concerned with his reputation and impressing his celebrity clients that he allowed it, until they just got in too deep to recover. It was pure hubris." Biderman rejects that view. "Lipper was absolutely, totally involved in the business on a daily basis," he says. Asked by BusinessWeek how this could have occurred, Biderman says: "There will be an appropriate investigation that will deal with that."

Lipper, a 61-year-old, boyish-looking bon vivant, grew up in the South Bronx, the bright son of a shoe salesman. Friends say "The Lip," as he is sometimes called ("he loves to hear himself talk," says one), is a consummate self-starter with a fiercely competitive spirit. He attended both Columbia University, graduating Phi Beta Kappa, and Harvard Law School on scholarships, topping his education off with a master's degree from New York University's School of Law. He was then a Ford Foundation Fellow at the University of Paris.

Despite his humble origins, he made a brilliant marriage. In 1966, he wed the daughter of oil and gas magnate and philanthropist Joseph Gruss. Her family was one of New York's richest, worth an estimated $500 million when the patriarch died in 1993. The match hoisted Lipper onto the fast track. In 1969, after brief stints at law firm Fried, Frank, Harris, Shriver & Jacobson and the Dept. of Commerce, he joined Lehman, later becoming one of the firm's youngest managing partners, at 32. Says writer Michael Thomas, a former Lehman partner: "Ken has always had a knack for ingratiating himself. Of course, Evy's money didn't hurt him, either."

In the mid-1970s, Lipper moved to Salomon, where his legal knowhow and financial savvy made him a top dealmaker. One transaction involving Becton, Dickinson & Co. (BD), the Franklin Lakes (N.J.) medical-products maker, got him entangled with the SEC. In 1978, in what became known as the Midnight Raid, Lipper and several colleagues organized a telephone stock-buying blitz in an effort to get others to sell their BD stock at a premium, according to SEC documents. The blitz, according to the SEC, amounted to an undisclosed and illegal bid to take over the company. Lipper, along with Salomon, was found by a Federal judge in the Southern District of New York to have aided and abetted securities-law violations. The charge could have resulted in Lipper's being permanently barred from the securities industry. Lipper and Salomon, however, hammered out a settlement with the SEC, without admitting or denying liability, with a promise to obey the law in the future. The case was later terminated. In 1982, Lipper cashed out, with an estimated $15 million, when Salomon went public.

Lipper was always fascinated by power. He once told Columbia students that he had closely studied the literature about it, often rereading the stories of Hadrian, Antigone, and Richard III. Politics was a natural next step. In 1983, he became a deputy mayor, a position he held for three years. Lipper got kudos for his tough negotiating style against various Koch foes, such as the Port Authority of New York & New Jersey. But, says a former political ally, "one of the things you're not supposed to do in politics is remember personal problems with people. And people felt that Kenny did."

For example, in 1985, allegedly owing to a personal vendetta, Lipper thwarted real estate developer David Walentas' plans to develop the Brooklyn waterfront. The story of Lipper's aggressive maneuvering against Walentas was the subject of a riveting May, 1985, New York magazine cover called "On the Waterfront." Lipper, say sources, blamed Walentas for the suicide of a friend they had in common, J. Frederick Byers III. Byers and Walentas had been business partners. But the sources also say Lipper may have been using the situation in order to befriend Byers' widow, the daughter of CBS chieftain William S. Paley, and her glitzy Park Avenue set, which included Byers' sister-in-law Amanda Burden and her then-husband, Carter, a businessman and Vanderbilt heir. Only since 1998 has Walentas been able to develop the part of Brooklyn situated down under the Manhattan Bridge overpass (DUMBO). Says Biderman: "Ken did what was in the city's best interest, in terms of trying to keep as many manufacturing jobs in Brooklyn as possible."

Toward the end of his City Hall stint, Lipper got wind that Oliver Stone was looking for a Masters of the Universe type to advise him on a movie to be called Greed. Initially, he balked. But once he persuaded Stone to be somewhat more sympathetic to the Street, he joined in with gusto, penning some of the punchy dialogue for what became Wall Street. He coached Michael Douglas and Charlie Sheen in their roles. He even got to appear briefly toward the end of the film as a dealmaker in a boardroom scene. Later, he wrote the novelization of the screenplay. (A myth has somehow been perpetuated that he wrote the book on which the film was based.)

Lipper fell in love with Hollywood, say friends. It was a busy time because he had just started Lipper & Co., primarily to manage his family's fortune. On weekends, he worked on a screenplay based loosely on his brief political career. The movie, City Hall, which Lipper also produced, starred Al Pacino, a boyhood friend, and John Cusack. It appeared in 1996 to tepid reviews. That didn't deter Lipper, who was already building a bicoastal life. Before long, he had opened an office in Los Angeles. He bought a house in Santa Monica and hung out in Aspen, Colo. He also became a trustee of Robert Redford's Sundance Institute in Utah, which funds and promotes independent filmmakers. By the end of the decade, Lipper had more than a toehold in Hollywood. He had won Tinseltown's ultimate honor--his Oscar.

Back in New York, Lipper's glitzy Hollywood lifestyle did not appeal to his wife, say friends. Evelyn preferred a quieter existence. After the divorce, Lipper moved from their uptown five-story house to edgier downtown. He bought and began to redesign a multimillion-dollar West Village townhouse (bragging that his architect was the son of I.M. Pei). Lipper quickly became a man-about-town, dating starlets and hanging out with "the Robert De-

Niro crowd," according to one friend. "Here is a guy who had a midlife crisis of epic proportions," says a longtime family friend, adding that there is now an estrangement between Lipper and some family members.

Many people believe that Lipper's changed lifestyle, varied career, and multiple roles had a bearing on his hedge fund's demise. "He was an absentee landlord," says one investor. When the market continued to sour in 2001, with numerous companies teetering on the brink of bankruptcy, Strafaci and Visovsky--who had spent 13 years, almost their entire careers, working for Lipper--started buying the distressed securities of companies such as Global Crossing, Calpine (CPN ), and Kmart (KM ), according to Race Rock's lawsuit. In particular, the two stocked up on convertible preferreds, which can be converted into common stock at a set price. The problem is that although those stocks act like junk bonds, paying high dividends, their holders get little or nothing if a company goes bankrupt. Meanwhile, Lipper's marketing materials stated that 70% of its securities were investment grade. Some investors estimate that more than half of the portfolio consisted of risky securities. Strafaci disagrees: "The issues were all appropriate and standard for a U.S. convertibles portfolio." Adds Biderman: "They may have been illiquid securities, but not speculative in that they were fly-by-night companies."

The Strafaci-Visovsky duo had been lowering credit quality to pump up the yield, according to Mark Friedman and Adam Stern, the managers called in to take over the portfolio after they left. What's more, the fund's stock hedges weren't nearly enough to offset losses on the bonds--especially as interest rates and stock prices fell in tandem, according to sources. Says Charles Gradante, president and CEO of Hennessee Group LLC, a hedge-fund advisory and research firm: "Although [Lipper's fund was] classified as a hedge fund, Lipper often didn't hedge his convertible bond exposure."

That wasn't all. Most fund managers use an independent third party to value--or "mark to market"--the seldom-traded securities every day. But the Lipper portfolio was rarely valued, and Strafaci and Visovsky did it on their own. "Few legit players do this themselves. It's almost a recipe for fraud," says the chairman of a respected money manager who also runs a convertible arbitrage fund. Biderman, along with another executive vice-president, Stephen Finkel, signed off on the valuations, according to Strafaci. Biderman claims many hedge funds mark their securities internally.

Biderman and Lipper had met in the Koch Administration, where Biderman was finance commissioner and later housing commissioner. Biderman was the closest to what the traders were doing, say insiders, but he had scant knowledge of convertible arbitrage. "It was the responsibility of Lipper, Biderman, and Finkel to have the fund officially audited. Abe and Steve, especially, were a very intimate part of the process," say Strafaci. Biderman says the funds were officially audited. (Strafaci told BusinessWeek that he and Visovsky were starting their own convertible arbitrage fund.)

Lipper's friends say the events of the early part of the year threw Lipper into deep distress and that he dropped out of circulation. He was rarely seen at favorite haunts, such as the Council on Foreign Relations or the white-shoe Century Assn. "Kenny has been through emotional hell," says an old friend. In the late summer, however, Lipper resurfaced, lunching with Koch at Midtown Manhattan's San Pietro--known, as one critic puts it, for its "noisy power lunch." Although Koch denies it, some speculate Lipper had met up with his old mentor for some career advice.

He may need it. Some investors want to remove him as the liquidating trustee of Lipper & Co. "How can someone who has possibly committed fraud and almost certainly breached his fiduciary duty act in the best interest of his investors?" asks one investor. Others are incensed that Lipper's distribution plan doesn't require him to give back any of the millions in performance fees, based on grossly inflated valuations, he collected for years. "He's paying himself for losing investors' money," says Mark Ressler, a lawyer for several investors. Other attorneys in the case say there's little doubt that investors will file damage suits against Lipper and possibly against PwC. Says PwC's Silber: "We see no reason why we should be sued."

Worse for Lipper is that his painstakingly crafted image may be irrevocably tarnished. As a broker in the movie Wall Street says, in a line Lipper might well have written: "We're all just one trade away from humility."

By Marcia Vickers

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