When Hedge-Fund Selling Bites Wall Street

Aug 2006 // The Wall Street Journal

Hedge funds are big business on Wall Street. And managing the issues of selling them is becoming a headache for some firms. Pipe Distributors Inc., a Texas company that buys and sells oil-field pipe, and its profit-sharing and retirement plans this year filed an arbitration claim against Morgan Stanley, saying a broker at the big Wall Street firm in 2001 invested $2.5 million for it in a hedge fund but failed to disclose the broker received a 25% cut of the fund’s profit. The fund ran into trouble and Pipe Distributors, a longtime Morgan Stanley client, had a loss of about $725,000. The case is pending.

Although the firm was a client of Morgan Stanley, the brokerage house has distanced itself from the case, saying the broker didn’t tell the firm he had made the investment in the hedge fund.

Furthermore, it says, the transaction wasn’t negotiated and completed on Morgan Stanley property and Pipe Distributors knew it wasn’t a Morgan Stanley-related investment.

The broker, who still works at Morgan Stanley, says he told Pipe Distributors the investment wasn’t connected to Morgan Stanley and disclosed his financial ties to the hedge fund.

“The broker was clearly looking out for his own economic interest, not that of my client, and Morgan Stanley is responsible for the actions of its employees,” says Tom Ajamie, the lawyer representing the pipe company. The brokerage house and the broker, Bodie Pyndus, declined to comment beyond what they have already said in filings related to the case.

Hedge funds are private investment partnerships that historically have catered to the wealthy and big institutions.

Investors who post losses often have limited recourse. But increasingly, Wall Street firms like Morgan Stanley are peddling hedge funds to clients who agree in advance to settle most disputes through arbitration — the clients sign agreements when they open an account saying if they have a beef with the firm they are usually required to seek recourse in arbitration, not by way of lawsuit. That is what the Texas pipe company has done.

Its case casts a spotlight on hedge funds as an increasing securities-industry profit center and the potential pitfalls. In 2005, for instance, a division of Canadian Imperial Bank of Commerce was ordered to pay almost $3.6 million to 11 wealthy investors who lost $5.5 million investing in a New York hedge fund marketed by the firm.

Morgan Stanley’s “code of ethics and business conduct” says employees should avoid any investment that could interfere or give the appearance of interfering with their responsibilities to the firm. One potential trouble spot: acquiring an interest in a transaction involving the firm or a client.

In the case of Pipe Distributors, in September 2001 Morgan Stanley broker Mr. Pyndus encouraged the company to invest retirement funds in hedge fund Enhanced Capital Partners.

Mr. Pyndus, based in Plano, Texas, said the fund fit the company’s conservative investment objectives.

Mr. Ajamie says the investment was high risk, demonstrated by the fact that it closed its doors just months after his client invested in it. Pipe Distributors lost about 30% of its $2.5 million investment.

Morgan Stanley says it was aware that Mr. Pyndus had formed a company called RowPyn Investment Partners, an advisory company, and told him he wasn’t allowed to solicit clients for any funds associated with the partnership.

It says it didn’t know of Mr. Pyndus’s relationship with Enhanced Capital, the hedge fund, and Morgan Stanley had nothing to do with the transaction between Mr. Pyndus and Pipe Distributors, a deal it says was negotiated and completed at the broker’s home and isn’t mentioned in any monthly statements from the firm.

While Mr. Pyndus works for Morgan Stanley, the brokerage house says it isn’t responsible for the losses because “numerous authorities” recognize that a brokerage house can’t be held responsible for the “selling away” of one of its brokers unless the investment was unsuitable, misrepresented or “otherwise improper” for the customer or the firm knew or should have known of the broker’s activities. It didn’t give examples of those authorities.

It maintains the investment while sold away was appropriate and it couldn’t have reasonably known about it.

As for Mr. Pyndus, he says that Pipe Distributors was aware the investment wasn’t associated with Morgan Stanley, that the client was aware it could lose money and that he had an economic interest in it.

He says unfortunately for investors, one of the fund’s managing partners suffered from severe depression and stopped monitoring the fund’s investments, leading to the losses.