Bayou Creditors Sue Goldman

With their chief tormentor, Samuel Israel, safely behind bars, creditors of his collapsed hedge fund can turn their ire on others.

Bayou Group’s creditors have sued the hedge fund’s prime broker, Goldman Sachs, alleging that it failed to detect the ongoing fraud and did not investigate suspicious activity there. The suit, filed in late May, is the latest by a hedge fund’s investors or creditors seeking to hold a service provider accountable for their clients’ fraud.

The case has been referred to arbitration, The New York Times reports. The creditors are seeking $20 million from Goldman. The collapse of Bayou cost its investors some $450 million.

According to the creditors, Goldman knew that Bayou was reporting double-digit returns to investors, even though Goldman Sachs Execution and Clearing’s monthly statements from August 1999 until August 2005 showed more than $88 million in losses.

The claims of 18% returns in Bayou marketing material requested by Goldman was “so completely inconsistent with the actual returns the Bayou Funds had been realizing in their trading accounts at G.S.E.C., in which they had done nothing but lose money.” Goldman’s risk management department in January 2004 reportedly listed three Bayou funds among its top 10 money-losing clients, including one Bayou fund at the top of the list with $35 million in losses.

“Through either gross negligence or a willful choice to ignore the signs of fraud, G.S.E.C. failed to diligently investigate the red flags it was made aware of it, to contact Bayou’s auditors to request additional information, or to alert the appropriate authorities of what it had learned,” the suit alleges.

Goldman declined to comment on the suit.

In February, Bayou’s unsecured creditors won the right to investigate Goldman’s potential role in the hedge fund’s collapse.