You Can't Cheat an Honest Man - James Walsh [40]
At the end of each quarter, Weyerhaeuser received a short statement showing its investment and its gains. Like most Hedged Investments investors, Weyerhauser staff didn’t question the temperamental genius down in Denver. In the spring of 1988, Weyerhaeuser gave Donahue another $5 million. But this time, it made a request. It split the money into two brokerage accounts handled by Kidder, Peabody and Morgan Stanley—but available to be traded by Donahue as he saw fit.
This was a smart move. By looking at the monthly brokerage accounts, Weyerhaeuser could check for itself how Donahue was doing. This was the first time anyone had managed to audit Donahue’s performance.
As it turned out, the timing was good for the temperamental genius. Donahue managed to make money steadily for about a year. In November 1989, though, he had to do some explaining. The brokerage reports showed huge losses from a large number of call options on United Airlines stock—which had dropped sharply in November. Even more disturbing: the reports showed no offsetting investments to act as a hedge against the United Airlines options.
Donahue reassured Weyerhaeuser. He said the calls had been fully hedged by puts in the main Hedged Investments portfolios, where Weyerhaeuser still had most of its money. To prove his point, he transferred money into Weyerhaeuser’s separate accounts. He allowed Weyerhaeuser to assume that this money was its share of profits on the UAL puts. This is a typical tactic used by Ponzi perps trying to buy time.
Weyerhaeuser money managers were calm for a few months. But the monthly reports continued to show a large number of UAL calls; and there were still no hedges in Weyerhaeuser’s separate accounts.
In February 1990, Weyerhaeuser contacted Donahue again. They were worried. In April, the company’s money managers flew to Denver for a face-to-face meeting. Donahue was able to convince them that he was sticking to his model.
In June and July, as the price of UAL common stock—and related call options—fell, the Weyerhaeuser people called Donahue several times a week. Finally, they couldn’t take his word any more. In August, they demanded an accounting of the company’s funds in the pooled account.
This demand broke Donahue. He admitted to Weyerhaeuser money managers that he couldn’t provide an accounting—and that there was no hedge in Hedged Investments.
On August 30, Hedged Investments filed for voluntary bankruptcy pursuant to Chapter 11 of the U.S. Bankruptcy Code. On September 7, the case was converted to a Chapter 7 liquidation and the bankruptcy court appointed a trustee. In a videotaped message, Donahue tearfully told investors that he had lost all of their money. Specifically, he said:
It is with deep remorse that I inform you that the Limited Partnerships in which you are a member have incurred a very significant financial loss.... At the request of many individual investors to keep the extent of their participation confidential, the total dollar amount of loss will be disclosed to you through correspondence and after a final accounting, and not at this semi-public meeting. The loss is extensive and involves almost all of the total assets of the fund.... My words at this point cannot possibly alleviate the emotion or financial impact on each person involved nor can they express the deep sorrow I have over this incident.
He blamed the collapse on a general stock market decline caused by Iraq’s invasion of Kuwait, which presaged the Gulf War.
However, after the initial panic over the losses subsided, two former employees said Donahue had told them as early as September