The U.S. Securities and Exchange Commission yesterday filed a civil injunctive action against the managers of a group of hedge funds known as the Bayou Funds, alleging that they misappropriated millions of dollars in investor funds.

The SEC’s complaint alleges that, beginning in 1996 and continuing through the present, the managers, Samuel Israel III of New York and Daniel Marino of Connecticut, defrauded investors in the funds and misappropriated millions of dollars for their personal use.

The commission’s complaint alleges that from 1996 through 2005, investors deposited over US$450 million into the Bayou Funds and a predecessor fund. It claims that during that period, Israel and Marino defrauded current investors, and attracted new investors, by grossly exaggerating the funds’ performance to make it appear that the funds were profitable and attractive investments, when in fact, they had never posted a year-end profit. The SEC’s complaint also alleges that, in furtherance of their fraud, Israel and Marino concocted and disseminated to the funds’ investors periodic account statements and performance summaries containing fictitious profit and loss figures and forged audited financial statements in order to hide multimillion dollar trading losses from investors. These allegations have not been proven.

The commission is seeking permanent injunctions for violations of the antifraud provisions of the federal securities laws against Israel, the founder of and investment adviser to the funds; Bayou Management, the investment adviser to the funds; and Marino, the chief financial officer of Bayou Management. In addition to injunctions against all of the defendants, the SEC also seeks disgorgement of ill-gotten gains, prejudgment interest, and civil money penalties.

Additionally, the SEC has requested that the court freeze the defendants’ assets and appoint a receiver to marshal any remaining assets for the benefit of defrauded hedge fund investors. All of the defendants have consented to the freeze of assets and appointment of a receiver. The requested relief is subject to court approval.

Yesterday, the U.S. Attorney for the Southern District of New York also announced that it has filed criminal fraud charges against Israel and Marino. And, the Commodity Futures Trading Commission announced that it has filed an action arising from the same conduct too.

Linda Chatman Thomsen, director of the Division of Enforcement, said, “The action filed by the SEC today, together with the parallel criminal proceedings instituted by the United States Attorney and the action brought by the CFTC, demonstrate that hedge fund managers who defraud their investors can expect a comprehensive and vigorous enforcement response.”

Among other things, the complaint also alleges that: they overstated the funds’ 2003 performance by claiming a US$43 million profit in the four hedge funds, while trading records show that the funds actually lost US$49 million; in 1999, Marino created a sham accounting firm, “Richmond-Fairfield Associates,” that he used to fabricate annual “independent” audits of the funds and attest to the fake results that he and Israel had assigned to the funds; that they stole investor funds by annually withdrawing “incentive fees” that they were not entitled to receive because the funds never returned a year-end profit; that they largely suspended trading securities on behalf of the funds by mid-2004 and transferred the US$150 million in remaining assets for investment in fraudulent prime bank note trading programs and venture capital investments in non-public startup companies; and, continued to send periodic statements and financial statements to investors describing purportedly profitable hedge fund trading activities through mid-2005.