The Ponzi fraudster who took $450m, and then his own life… or did he?

published 20 June 2008

For nearly a decade, Samuel Israel III did a terrific impersonation as a markets whizz at Bayou Management, the hedge fund that collapsed in 2005 after defrauding investors out of $450m. "But as much nerve as that performance took," says The Washington Post, Israel may now be playing "a role that requires even more gall". American authorities strongly suspect he has faked his own suicide and is now on the run.

Last week, Israel, 48, kissed his girlfriend goodbye and set out to drive alone to a Massachusetts jail to begin a 20-year sentence. He never arrived. Police found his car on a bridge just north of New York City. Scrawled on the dusty hood were the words: "Suicide is painless."

If Israel is indeed on the run, he will have made a mug of the judge, who, swayed by his professions of "saturating guilt and profound shame", let him travel unescorted. Yet she's just one in a line of victims, says The New York Times. As well as hundreds of rich investors, these include his Rabbi, who was mystified to hear Israel profess in court that he had "always been a person of Christian faith".

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During Bayou's heyday, Israel rented a $32,000-a-month mansion from Donald Trump. "But Bayou never made a bean between its 1996 inception and 2005 demise," observes Investors Chronicle. Little more than a Ponzi scheme, it paid old clients with money taken from new ones.

Its high-tech trading floor, with aquariums containing pet snakes, was real. But its "reports to shareholders were fiction, and had been signed off by a fictional firm of accountants", set up by Bayou CFO Daniel Marino. Its glowing results seemed plausible because they weren't too over-the-top. And Israel's CV made for impressive reading. It included a stint as "head trader" at admired hedge fund Omega Advisors. Chairman Leo Cooperman later said that Israel had held a "low-end job" and "could barely tell the difference between a stock and a bond".

But what really swung investors was his name. To some it "had the whiff of Rockefeller about it", says The Washington Post. The Israels were a respected trading family from the South. Israel's grandfather and namesake, Samuel Israel, built up a commodity trading powerhouse that sold for a fortune in 1981. Indeed, Israel cited the pressure to live up to the family's legacy as a reason for the fraud. "I cheated my investors because I did not want my family to see me as a failure."

Rumours of irregularities began in 2003, but Bayou staggered on until summer 2005, when Israel told investors he was winding up the funds and would return their money. A worried investor made the trip to Bayou's deserted Connecticut headquarters. He found a six-page letter, written by Marino, which doubled as a "suicide note and confession". "If there is a hell," Marino wrote, "I will be there for an eternity."

Threatened suicide seems a hallmark of this swindle. Fortunately, Marino is still with us, albeit behind bars serving a 20-year sentence. But what of Israel? Police say they have ruled out suicide, although they're not revealing why. A manhunt has now been launched, complete with wanted' posters, describing Israel as "armed and dangerous". Police are continuing to keep an eye on the Hudson river in case his body turns up, but most former Bayou investors are sceptical. "The only place this guy will wash up," says one, "is a beach in the Bahamas."

What makes smart investors dumb?

In apparently joining the ranks of great conmen on the run, Sam Israel may hope to emulate the likes of legendary 1970s crook Robert Vesco, who may or may not have died in Cuba last year; and Asil Nadir of Polly Peck, still in Cyprus. But the real mystery is why so many apparently sophisticated investors fell for his wiles.

Of course, Bayou is not the only hedge fund to take punters for a ride, says The Economist. Others include Refco, Philadelphia Asset Management and the "granddaddy" of all collapses, Long Term Capital Management. The sector's opacity helps: hedge funds don't publish much information, so a fund can "go off the rails for a while undetected". And because the strategies "usually sound like rocket science, investors may suspend their own critical faculties". It's not just greed that makes smart investors dumb, says Forbes. A "predisposition to folly is hard-wired into the human species".

As Arizona University psychology professor Robert Cialdini notes, the brain takes short cuts when faced with complex decisions. We rely on "suggestions by influential people; we gravitate to something if it seems to be unavailable to everyone else, and we trust strangers who appear to like us". Israel, who majored on his reputation as a "folksy Wall Street veteran", pressed these buttons and "worked hard to seem like a guy with nothing to hide".

But his trump card was his provenance. As Cialdini says, one of the most effective, and dangerous, shortcuts "is relying on someone's family background and pedigree as proxies for reliability". It's a lesson investors in Bayou learned the hard way.