8-21-13 10:13 AM EDT | Email Article

By Al Lewis


Philip Falcone, the billionaire hedge-fund manager who must actually admit wrongdoing in a regulatory settlement, did something many people on Wall Street wish they could do.


He put a short squeeze on the Vampire Squid.


In 2006, Goldman Sachs (GS) , as the great cephalopod is officially known, was shorting distressed high-yield bonds from a bathroom-fixtures manufacturer called MAAX Holdings Inc. Goldman, one of the most powerful investment banks in the world, was also encouraging its customers to do the same.


Poor MAAX. The company was just trying to make shower doors, sinks and other products people need to wash themselves clean. Poor Falcone. His Harbinger Capital owned a ton of these MAAX bonds and Goldman was flushing them right down the drain.


It is an awful thing to learn Goldman is betting against a security when you are betting for it. People often respond to such news in crazy ways. You might remember a firm called Lehman Brothers, back in 2008, blaming the entire financial crisis on short-sellers -- including a short-selling cabal led by Goldman. Lehman fired back by getting the Securities and Exchange Commission, to put a temporary ban on shorting certain stocks.


As for Falcone, well, he responded in his own way. He grew up playing hockey in a dying Minnesota mining town not far from the Canadian border. He made it to the pros in Sweden and now owns a piece of the NHL's Minnesota Wild. In hockey, if another player smacks you against the wall, you find a way to rip off his helmet and pound his face.


In hockey, this is called sportsmanship.


Falcone, according to his confessional settlement with the SEC, sought revenge against his opponent.


Falcone bought up every piece of the MAAX bond offering there was. He even bought more than there was. According to the SEC, he purchased 22 million more bonds than had ever been issued (because on Wall Street, you can always buy stuff that doesn't actually exist.)


This move to corner the market more than doubled the price of the bonds that Goldman was trying to short and it put Goldman right up against the wall. Goldman now had to buy these bonds to cover its short position.


That's when Falcone said something like, "Hey, squid. You want some MAAX bonds? I got your MAAX bonds, right here," and then demanded that Goldman pay significantly more than face value for the bonds.


Now, I am certain that this play can righteously be labeled illegal market manipulation the same way punching someone in the head can be considered assault. This call doesn't happen very often, though, in an arena where such violations occur all the time.


The SEC came down on Falcone a lot harder than it ever came down on the squid, forcing not just an $18 million settlement, and a five-year ban from the industry, but a rare admission that he actually did something wrong.


"Today's charges read like the final exam in a graduate-school course in how to operate a hedge fund unlawfully," said Robert Khuzami, in 2012, when he was then director of the SEC's enforcement division and announced the charges against Falcone.


I, very naively, had no idea business schools taught such courses. Perhaps now that Falcone has been banned from his industry, he can go back to his alma mater, Harvard University, and teach them.


"Clients and market participants alike were victimized as Falcone ... manipulated the market for certain bonds ... and violated trading rules intended to prohibit manipulative short sales," Khuzami added.


Unlike Falcone, nobody at Goldman had to admit guilt in 2010 when the firm agreed to pay the largest fine in SEC history for allegedly misleading investors in a subprime mortgage deal.


The SEC, under different leadership, was going much easier on folks then. Goldman only copped to making few little marketing mistakes. And Khuzami did not go so far as to suggest anyone there should teach a graduate course in how to unlawfully run an investment bank.


The SEC has nailed Falcone for other indiscretions, including secretly borrowing $113.2 million from his hedge fund, at a super-low interest rate, to pay his personal taxes.


It should be noted he kept his own fortune in the funds, and repaid this loan after the SEC started snooping around, but it still sounds like taking the neighbor's car for a joy ride and then telling the cops you were only borrowing it.


As the financial market collapsed in 2008, Falcone also changed the rules on who could redeem their money from his funds and who couldn't, favoring some investors over others, according to the SEC settlement.


He was an aggressive hockey player and the SEC has tossed him in the penalty box. He told CNBC in an emailed statement earlier this week that he's pleased to have the settlement behind him, and that he's not closing down his fund. So game on. Read related commentary: Falcone can start planning his comeback.


As for Goldman, well, the folks over there play a pretty aggressive game of hockey, too. And yet we see from the subprime case that the referees have their backs.

-Al Lewis; 415-439-6400; AskNewswires@dowjones.com


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08-21-13 1013ET

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