Kamikaze Capital

14 October 2005

Wood River and Durus Capital both got into trouble for taking big bets on illiquid smallcap stocks. Why were they prepared to take such risky punts? Because of the bizarre incentives in the hedge fund industry.

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Wood River, an Idahobased hedge fund with some $275m in investments, ran up losses of up to $100m on a 40% investment in Endwave, a small highfrequency equipment maker. The fund failed to disclose its stake until October 7.

On October 13, the Securities and Exchange Commission filed a civil suit against the fund and its manager, John Whittier. A court also froze both the firm's and Whittier's assets.

Durus Capital Management, a South Norwalk, Connecticutbased hedge fund, failed to disclose accumulating stakes of 78% in Aksys Ltd and 33% in Esperion Therapeutics Inc between 2002 and 2003, according to the guilty plea filed by chief operating officer at Durus, Douglas Schmidt. The Securities and Exchange Commission alleges that the undisclosed purchases served to artificially inflate the market prices of both stocks. The hedge fund collected some $40m in performance fees in the first six months of 2003.

According to SEC rules, an acquirer must report accumulation of a stake of 5% or more of the voting shares of a publicly traded company within 10 days of the purchase.

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