Samuel Israel III, the founder, and Daniel Marino, the CFO of the Stamford, Conn.-based Bayou hedge fund, pleaded guilty in federal court.
Prosecutor Margery Feinzig said Bayou issued fictitious weekly, quarterly and annual reports that inflated its profits to attract new investors and lull existing investors into keeping their money in the fund.
Israel, 46, admitted sending out false financial information to current and prospective investors "which made it appear that Bayou was doing better than it really was."
Israel pleaded guilty to three counts: conspiracy to commit investment adviser fraud and mail fraud; investment adviser fraud; and mail fraud.
Marino, who is also 46, pleaded guilty to mail fraud, wire fraud, investment adviser fraud, and conspiracy to commit investment adviser fraud.
The maximum sentence for the investment fraud counts are five years each; for mail fraud and wire fraud, the maximum is 20 years. Sentencing guidelines, however, are likely to call for considerably lower sentences.
Sentencing for both executives was set for Jan. 9.
Authorities began investigating Bayou after investors received a July 27 letter from Israel announcing that Bayou would return their money and shut its doors. Investors say they have not received refunds.
Bayou is the latest in what regulators say is a growing number of frauds involving hedge funds, which are largely unregulated and traditionally serve institutions and wealthy investors. Hedge funds profit by using unconventional techniques, such as short-selling, or betting on falling markets to make a profit during market downturns. Hedge funds typically are active traders and can use techniques off limits to mutual funds.
Bayou investors filed several lawsuits alleging that Bayou executives hid massive investment losses by raising new money to pay withdrawing investors and to pay themselves fees and commissions they had not earned. One lawsuit referred to Bayou as a classic Ponzi scheme.
Ross Intelisano, an attorney who represents some of the investors, said his clients invested between $250,000 and $1.5 million in Bayou. Some clients invested their retirement funds, he said.
One investor, the Jewish Federation of Metropolitan Chicago seeking more than $4 million.
The firm earlier this year reported to investors that it had assets of $440 million. Last year, it told investors that it had more than $500 million in assets.
In the last five years, the U.S. Securities and Exchange Commission brought 51 cases charging hedge fund advisers with defrauding investors of more than $1 billion. According to the agency, there are now about 7,000 hedge funds managing $870 billion in assets, a 260 percent jump over five years ago.
By Jim Fitzgerald