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Card Shark's Son Busts

Matthew Goldstein

Jeffrey Thorp, the New York hedge fund manager charged this week with manipulating nearly two dozen small-cap private placements, has a gambler's pedigree.

His father, Edward Thorp, helped found the hedge fund business -- and also made a name for himself teaching card players one of the best-known systems for winning at blackjack.

In 1962, the elder Thorp, a math whiz and a university professor, published Beat the Dealer, a book that suggested it was possible to use a mathematical system to win by counting cards. The book caused such a stir that it led the Las Vegas casino industry to stiffen its precautions against card counting.

In card counting, a gambler tries to keep track of which cards have been dealt by the dealer, in order to determine the probability of getting a winning hand.

After cracking the casinos, the elder Thorp went on to tackle Wall Street, starting up one of the first hedge funds -- Princeton/Newport Partners. Relying on Thorp's mathematical trading strategies, the limited partnership was highly successful, generating 20% annual returns for years.

In 1989, Princeton/Newport ran into trouble with regulators over allegations of insider trading. Thorp was never implicated in any wrongdoing, but the fund shut down the following year.

Fast forward 16 years later, and now its Thorp's son, Jeffrey, who is in trouble with regulators over the trading strategies of his Langley Capital hedge fund complex.

On Tuesday, Thorp and Langley Capital agreed to pay a $16 million fine to the Securities and Exchange Commission to settle allegations arising from a two-year-old investigation into manipulative trading in the $18 billion-a-year market for PIPEs, or private investments in public equity. The penalty is the largest settlement assessed to date by the SEC in the investigation.

The PIPEs investigation is focusing on allegations of abusive short-selling by hedge funds trying to take advantage of the usual decline in shares of companies that sell these deals.

A short-sale is a market bet that a stock will decline in price.

Securities regulators, in a civil complaint filed in federal court as part of the settlement, charged Thorp with carrying out an illegal short-selling scheme involving 23 separate PIPE deals from 2000 to 2002. Some of the alleged unlawful trading by Thorp occurred in PIPE deals by AVI BioPharma(AVII Quote - Cramer on AVII - Stock Picks), MGI Pharma(MOGN Quote - Cramer on MOGN - Stock Picks) and TiVo(TIVO Quote - Cramer on TIVO - Stock Picks).

Thorp did not respond to an email request seeking a comment on the SEC settlement. His attorney did not return a telephone call. Scott Friestad, associate director in the SEC's enforcement division, whose group worked on the Thorp case, declined to comment about the hedge fund manager's father.

The elder Thorp, who lives in California, did not return a telephone call. A person answering the phone at his office said, "He isn't talking about that matter. He never talks about his family.''

It's not clear what the status of Jeffrey Thorp's Langley Capital hedge fund is these days.

A few years ago, Langley was one of the more active investors in PIPEs, a type of financing that often is a last-ditch attempt by a small company to continue operating. But it no longer ranks among the leaders when it comes to PIPE investors.

Presumably, the SEC investigation may have led Thorp to pull back on PIPE deals. Then again, the SEC investigation isn't the only legal problem Thorp has had to deal with in recent years.

Thorp and his Langley hedge fund were implicated, but not charged, in the federal prosecution of notorious short-seller Anthony Elgindy. Last year Elgindy and former FBI agent Jeffrey Royer were convicted on charges of conspiring to drive down the stock prices of companies they were shorting by leaking negative news about those companies on the Internet.

Prosecutors, in court papers, alleged that Thorp was a subscriber to Elgindy's online service and "traded on misappropriated information.'' The misappropriated information Elgindy and Royer were accused of spreading involved allegations stemming from government investigations.

Federal prosecutors in New York had indicated that they intended to call Thorp as a witness during the trial. But he was never called upon to testify.