The manager, who has since bet much of his Harbinger Capital Partners money on a cash-strapped wireless telecom company, disclosed on Thursday that U.S. securities regulators are considering filing civil fraud charges against him and what's left of his once $26 billion hedge fund empire.
Falcone and two top lieutenants have received Wells Notices from the U.S. Securities and Exchange Commission, Harbinger Capital parent Harbinger Group Inc <HRG.N> said. This means the regulators are considering bringing an enforcement action against them over a number of potential violations, including alleged manipulative trading in debt securities during the period from 2006 to 2008. (http://www.reuters.com/article/2010/08/26/us-hedgefunds-falcone-idUSTRE67P22J20100826)
In previous regulatory filings, Falcone said that regulators were investigating his funds' trading in unnamed bonds. But those earlier filings had downplayed the potential seriousness of the matter.
Once a favorite with big name investors like Goldman Sachs Group Inc <GS.N> and Blackstone Group LP <BX.N>, Falcone's funds have disappointed recently. His Harbinger Capital Partners fund fell 11.6 percent through November, an investor said.
The timing of the trading being examined is of great interest because it coincides with the period that Falcone was making his big bet on the collapse of the U.S. housing market. That is a trade which catapulted him to hedge fund stardom along with a handful of other managers like John Paulson and Steve Eisman.
Falcone's fund did much of its initial subprime trading through deals set up by Deutsche Bank AG <DBKGn.DE>, say people familiar with the situation. Deutsche did not immediately return a call for comment.
A spokesman for Falcone declined to comment on the potential action by the SEC. The spokesman said he could not offer any more information about the alleged improper trading in debt securities the SEC is looking into.
A former employee said he doubted the trading issue involved the subprime trade because most of it involved buying credit default swaps on mortgage securities, and not building collateralized debt obligations as other hedge fund managers did.
The former employee said he did not know what trades the SEC might be looking at.
For Falcone, the notification from the SEC that it may file civil fraud charges against him -- officially called a Wells Notice -- marks the latest setback at the top of the hedge fund empire.
Harbinger now manages less than $4 billion and roughly half of the money is tied up in its investment in LightSquared LP <MOSAV.UL>, the upstart wireless telecom on which Falcone literally has bet the ranch. LightSquared is running low on cash and its outstanding debt trades at a steep discount as it fortunes have floundered due to a number of technical issues.
In recent years, Harbinger has angered his investors by closing his funds to redemptions and committing so much money to LightSquared. He has also angered investors by borrowing $113 million from his fund to pay his taxes without first notifying his investors.
Even though Falcone has since paid back the loan, the SEC began looking into the loan disclosure last year. Potential problems with the disclosure over the loan is another reason regulators are considering suing Falcone, said a person familiar with the matter.
The filing of the Wells Notice on Falcone and his funds was disclosed Friday in a regulatory filing by Harbinger Group, an investment company Falcone controls which has been buying up assets from his hedge funds.
Falcone, who grew up poor in Minnesota's mining region, came to Wall Street via Harvard College, where he was a star hockey player. After developing his expertise in credit markets as a high yield and distressed securities trader at Kidder Peabody, Falcone set off on his own, often returning to his roots and hiring former Harvard hockey players. He and is wife Lisa, a fixture in New York's social circles, moved into Penthouse mogul Bob Guccione's townhouse and have undertaken a lengthy and costly renovation.
Known for his demanding personality, Falcone upset many investors when he told them on Christmas Eve a few years ago that their money would be locked up for a long time. (With additional reporting by Katya Wachtel, and Jennifer Ablan, editing by Matthew Goldstein and Gerald E. McCormick)