High-Flying Falcone Clipped By Fraud Charges

NEW YORK ( TheStreet) - Fraud charges aren't a harbinger of bad things to come for embattled hedge fund titan Philip Falcone - they're his next big headache.

Falcone and Harbinger Capital Partners, the hedge fund he founded, have been charged with fraud, market manipulation and betraying clients in a civil suit filed by the Securities and Exchange Commission on Wednesday.

The SEC alleges that Falcone illegally used $113.2 million in client funds to pay his personal taxes, while also engaging in illegal bond and stock trading. The hedge fund manager is also accused of misappropriation in allowing some investors to pull $169 million from his floundering hedge fund. Separately, Harbinger agreed on to pay nearly $1.4 million to settle with the SEC on alleged illegal stock trading.

The charges were widely expected after previous media reports highlighted the SEC's inquest into Falcone's use of client funds for his personal finances and Harbinger's potentially illegal trading and redemption strategies.
Harbinger Group Phil Falcone

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

"Clients and market participants alike were victimized as Falcone unscrupulously used fund assets to pay his personal taxes, manipulated the market for certain bonds, favored some clients at the expense of others, and violated trading rules intended to prohibit manipulative short sales."

The SEC alleges that Falcone fraudulently took a $113.2 million loan from the Harbinger Capital Partners Special Situations Fund to pay his personal taxes. At the time, the fund was suffering losses and had suspended investors from redeeming their money. In that loan, the SEC says Falcone and Harbinger never asked for consent from investors and misrepresented details to its legal advisor, which approved the transaction.

The complaint alleges that Harbinger fund investors also suffered from preferential treatment for some clients, which allowed some clients to pull $170 million from otherwise locked-up funds.

The fraud and manipulation suits are civil charges, meaning that the SEC will its try its allegations against Falcone and Harbinger, potentially banning the once high-flying fund manager from the securities industry and corporate boards. However, the SEC hasn't recommended criminal charges, meaning that, as of now, the U.S. Department of Justice won't pursue a case that could land the manager in jail.

On Tuesday, Bloomberg News reported that the regulator would claim Falcone illegally borrowed client money to pay taxes and created a sweetheart deal with Goldman Sachs to exit his flagship fund.

The SEC is also pushing for "market manipulation" charges against the billionaire hedge fund guru in relation to bond investments in the debt of MAXX Holdings group.

The SEC alleges that from 2006 through early 2008, Harbinger allegedly orchestrated an illegal 'short squeeze' on the supply of the bond issue - after hearing of banks buying short positions in the security -- with the intent of forcing settlement with short sellers at inflated prices.

In that strategy, the SEC says Falcone raised Harbingers stake in MAXX bonds to approximately 13% more than their available supply. Having taken control of the supply of the MAAX bonds, Falcone then demanded that short sellers settle their outstanding MAAX shorts at unfair and manipulative prices.

Harbinger has been the focus of federal scrutiny for over a year after it was reported that Falcone used a $113 million loan in 2009 to pay personal taxes. The SEC investigation focused on whether the loan -- which was eventually revealed -- was disclosed in a timely fashion, according to the Wall Street Journal. According to its suit on Wednesday, the SEC claims that Harbinger misrepresented its financial situation to investors and its legal advisors.

Without admitting or denying guilt, Harbinger also settled an order that alleged the fund violated the Securities Exchange Act of 1934 in purchasing shares of an initial public offering during its restricted period and selling those securities short, in violation of Rule 105. As a result of the settlement, Harbinger will pay a disgorgement of $857,950, interest of $91,838, and a civil monetary fine $428,975.

Harbinger and Falcone have faced massive losses over the past year as a bet on high-speed wireless went south after 4G wireless provider LightSquared declared bankruptcy and wiped out most of Harbinger's near-$3 billion investment.

"Any allegations by the SEC of impropriety by Mr. Falcone or Harbinger are supported neither by the facts or the law," said Matthew Dontzin, counsel for Falcone, in a Tuesday statement related to the SEC's pending civil charges. "Should a lawsuit be brought it will be contested vigorously."

-- Written by Antoine Gara and Christopher Westfall in New York.