Art Institute of Chicago director A. Steven Crown listened intently as Dr. Conrad P. Seghers, a Texas trader with a doctorate, described his scientific method of investing.
Using charts and graphs, he showed Crown, chairman of the museum’s finance committee, how the venerable institution would be protected against losses, even in a declining stock market, by Seghers’ secret five-step trading strategy, according to court documents.
Eighteen months and $43 million later, Crown received a “Dear Investor” letter from Seghers’ little-known Dallas firm, Integral Investment Management LP. One fund in which the museum had invested $23 million had lost 90 percent of its value, the Oct. 23 letter said. And Crown couldn’t get information about a second fund in which the museum had invested $20 million, court documents reveal.
The staggering losses triggered a still-unfolding drama that includes an FBI investigation, a high-profile lawsuit by the museum, vehement denials by Seghers’ lawyer and a gag order by a Texas state court judge barring either side from discussing the case.
To museum officials, the losses are a clear-cut case of fraud in which Seghers promised one method of investing but instead followed another, far riskier plan.
More Top Picks Best Japanese Ice Ball Molds
But the sour investment also raises questions about the quality of advice from the museum’s longtime investment consultant, Kennedy Capital Advisors Inc., and the financial oversight provided by the museum’s blue-chip board.
The Art Institute draws its directors from among Chicago’s wealthiest families and top business leaders. The six-member finance committee headed by Crown, a partner in his family’s Henry Crown & Co., includes such figures as Marshall Field V, former publisher of the Chicago Sun-Times, and David Vitale, chief executive of the Chicago Board of Trade and the museum’s treasurer.
Yet on the recommendation of Kennedy Capital, a small Atlanta-based firm, the committee entrusted 6 percent of a $667 million investment pool to a trader whose strategy made little sense to many professional investors.
Another manager who listened to Seghers’ pitch two years ago said he declined to meet with Seghers again because he couldn’t get his questions answered–an experience that made him and others who heard Seghers’ patter wary.
“We could not make a good connection between the description they were providing about the strategy and what they said about their purported performance record,” said Brian Cornell, managing director of a Mesirow Financial Inc. subsidiary in Chicago. “The guys I talk to routinely came back with the same concern. They couldn’t get clarity on what the strategy was going to be.”
Crown and other museum directors did not return calls seeking comment. Kennedy Capital officials said they were asked not to comment by the Art Institute.
In an interview before the gag order was issued, Dallas attorney Lawrence Friedman, who represents Seghers and another Integral executive, James Dickey, denied the allegations. “The investments were properly handled,” he said. “Every penny can be accounted for.”
Heavy into hedge funds
The investments in question are called hedge funds or private partnerships used by institutional investors to minimize risk or maximize return. At midyear, hedge funds accounted for 59 percent of the Art Institute’s $667 million long-term investment pool, far surpassing traditional investments such as stocks and bonds.
Many institutions are cautious in their approach to hedge funds for several reasons. Hedge funds are less strictly regulated than mutual funds and other investments, less open to outside scrutiny and much harder to liquidate.
The Art Institute’s commitment to hedge funds is unusually large, experts say. Its concentration is much higher than that of institutions with far bigger endowments and more than seven times the average 8 percent allocation for leading universities, studies indicate.
By comparison, Northwestern University’s $3.6 billion investment pool allocates 17 percent to hedge funds. At Yale University, known for successful investing, 22.5 percent of its $10.7 billion endowment is invested in hedge funds.
“Hedge funds range from A to Z, and to paint them with a broad brush is like saying, `Investments are risky,'” said David Wagner, Northwestern’s chief investment officer. “The key is diversification.”
On that score, the Art Institute’s financials raise questions.
The majority of its $396 million hedge fund holding is invested in a single unidentified fund, according to the museum’s June 30 financial statements. That $295.7 million investment, which experts speculate is a fund composed of many hedge funds, includes paper profits, or unrealized gains of $102 million, according to the museum’s report.
Looking to reduce risk
The Art Institute, like many institutions, began investing in hedge funds in 1997 when its board, concerned that the long-running bull market was about to end, looked to reduce the risk of its portfolio losing value, according to Pensions & Investments, a financial industry weekly.
The museum is known, for instance, to have invested in hedge funds operated by American Express Asset Management Corp., a Minneapolis-based subsidiary of the well-known financial firm.
Those investments, combined with successful fundraising, fueled a 46 percent growth in the museum’s endowment since 1997, according to Art Institute financial statements.
As for Seghers’ Integral funds, the Art Institute’s finance committee believed they “would be relatively safe in the event the market declined,” Crown said in a sworn statement filed in conjunction with the court case.
Seghers said that the “proposed investments would have a high percentage of liquidity and would produce only very limited losses in the event of a market downturn,” according to Crown’s affidavit.
During a July 12 presentation to Art Institute officials and directors, Seghers and other Integral executives outlined their “highly proprietary” strategy, which involved using stock options to protect against losses of as much as 30 percent in individual stocks.
They said 70 percent of the fund would be held as cash, according to the Art Institute’s complaint.
“Our emphasis is on risk management rather than imprudent profit maximization,” Integral stated in a written presentation included in court documents.
Layers of liability
Yet Seghers’ investment technique appears as complicated as the web of partnerships and holding companies that allegedly link him to Samer M. El Bizri and Los Angeles-based Bizri Capital Partners Inc., also named as a defendant in the Art Institute’s suit.
More Top Picks Code Readers
The Art Institute alleges that $20 million of its money was funneled into a partnership controlled by Bizri Capital. Bizri and a Chicago attorney who has represented his firm in another matter could not be reached for comment.
After the Sept. 11 attacks sparked widespread financial losses, Kennedy Capital began pressing Integral about the status of the Art Institute’s investments.
At first, Integral assured Kennedy that the hedge funds did not suffer significant losses, according to court documents.
But six weeks later, the October “Dear Investor” letter told a different story. It said Integral’s Hedging Fund had suffered “enormous losses of capital” because of “unprecedented market declines.”
A Nov. 7 e-mail from Integral to Kennedy Capital about the museum’s $20 million investment in Integral Arbitrage Fund said the money, which the Art Institute claims it was assured would be readily available as cash, instead was locked up in investments that couldn’t be tapped, such as delinquent debt.
“At no time did the defendants disclose that they intended to invest … in such high-risk investments as distressed credit card debt,” Crown states in his affidavit. “We would not have approved such an investment.”
While the FBI looks into the mess, one of Chicago’s most respected institutions is forced to wrangle in a Dallas courtroom to recover what, if anything, is left of its investment.