UPDATE 3-U.S. SEC charges Falcone, Harbinger with fraud

Thu Jun 28, 2012 3:38pm IST

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By Svea Herbst-Bayliss

BOSTON, June 27 (Reuters) - The bad news keeps coming for Philip Falcone, once one of the hedge fund industry's biggest stars.

The U.S. Securities and Exchange Commission filed a lawsuit in federal court on Wednesday charging the 49-year-old billionaire with market manipulation, giving preferential treatment to several big clients, and borrowing cash from his hedge fund Harbinger Capital Partners to pay personal expenses.

"Today's charges read like the final exam in a graduate school course in how to operate a hedge fund unlawfully," Robert Khuzami, director of the SEC's division of enforcement, said in a statement.

The lawsuit comes just one month after LightSquared, a wireless telecommunications upstart backed by Falcone, which over time became his fund's biggest investment, filed for bankruptcy.

The one-two punch of the LightSquared bankruptcy and the SEC civil charges raise questions about Falcone's future in the $2 trillion hedge fund industry.

Once known as a savvy investor whose well-timed bet against the overheated housing market expanded his fund to $26 billion, Falcone has watched his assets dwindle to about $3 billion as he had to keep writing down investments in LightSquared.

Falcone and his lawyers said he will fight the charges, but did not elaborate.

Industry analysts and investors worry about how well Falcone can perform his duties as a money manager while defending himself.

"It is clearly a challenge to spend your time defending charges on the one hand and managing a fund on the other," said Richard Heller, a partner at law firm Thompson Hine. "It is like having two full-time jobs, at the same time."

News of the suit did not come as a surprise. Falcone first told investors about the SEC's potential plans late last year and months of settlement talks in Washington proved fruitless.

Regulators wanted to bar Falcone from operating as an officer of a public company. He is currently chairman and chief executive officer of Harbinger Group Inc.

The SEC in the lawsuit also charged Harbinger, as the adviser to the hedge funds, with securities fraud. A spokesman for Harbinger could not immediately be reached.

GOVERNMENT CHARGES

The case offers fresh evidence of just how feverishly the U.S. government is working to root out improper trading at hedge funds now that big U.S. pension funds are relying on them to help shore up retirement savings for average Americans.

The government listed a string of charges against Falcone, who has made headlines both for his investing prowess and his charitable gifts -- his wife made a spur of the moment $10 million donation to the High Line Park in New York in 2009.

Falcone, a former Harvard hockey star, and others manipulated the bond prices of bathroom fixtures maker MAAX Holdings Inc, between 2006 and 2008, the government charged.

Regulators also allege that Falcone treated his investors unfairly at the height of the financial crisis, when many of the fund's assets were tied up in the collapse of Lehman Brothers. He allegedly let out at least two big clients, even though he told others on Christmas Eve in 2008 that they would not be allowed to get their money back for quite some time.

The government said Falcone illegally gave himself a $113 million loan from the fund to pay for his personal taxes, something that made investors especially angry because they could not access their own money.

Falcone contends that lawyers signed off on his loan, which sources close to Falcone said he has repaid.

The case will pit Falcone, once one of Wall Street's most powerful figures, against governmental regulators in Washington, a place where he has had tough relations with lawmakers for some time.

During the fight to build out LightSquared after the Federal Communications Commission gave its tentative promise to proceed, Falcone ran up against powerful Iowa Senator Charles Grassley and his fierce opposition.

"It appears the FCC nearly granted billions of dollars in taxpayer assets to someone accused by our nation's financial regulator of having 'victimized' 'clients and market participants alike'," Grassley said on Wednesday. "Maybe the next time, the FCC won't be so dismissive about concerns raised about its business," the lawmaker said.

Separately, the SEC settled charges with Harbert Management Corp, which had given Falcone some initial investments and been a big backer. The regulator said the group had not properly watched over him during the alleged bond market manipulation.

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