Why Did Goldman Sachs Turn Against Phil Falcone?

Goldman Sachs submitted a withdrawal notice to Philip Falcone's Harbinger Capital Partners, a high-flying hedge fund that once managed $26 billion. Why did Goldman decide to pull all of its $120 million from Falcone's fund?

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Writer Lisa Falcone and businessman Philip Falcone attend NY TIMES Party at the C5 Resturant at The Royal Ontario Museum.

Investors in Falcone's main hedge fund are limited to withdrawing 25 percent of their investment each quarter, so Goldman will be an investor in the hedge fund through all of 2011.

The move to withdraw the funds was first reported by Bloomberg's Katherine Burton.

There's been a lot of speculation about the cause of Goldman's withdrawal. Burton wrote that the move came after Falcone withdrew $113 million from a fund to pay his taxes. The fact that the fund had suspended redemptions—meaning investors could not pull out—angered some investors. Why should the fund manager be able to pull money out of the fund when investors are blocked, some asked.

Burton also reported that Falcone's primary fund, Harbinger Capital Partners Fund, was down 15 percent for the year as of October 15.

But a source close to the matter says it was neither Harbinger's underperformance nor the tax liability loan that triggered the withdrawal. Instead, Goldman decided to pull its money out because the firm had seen such stellar returns that Goldman's initial investment had grown too large. More importantly, Goldman was unhappy with the concentration of Falcone's investments in illiquid investments.

Goldman initially made a small investment in Falcone's fund. But the early performance of the fund was so great that the investment grew in size to become one the Goldman hedge fund group's biggest positions. This had a distorting effect on the group's returns, which meant that when Harbinger did well so did the Goldman hedge fund group. When his funds performed poorly, the group at Goldman saw its overall performance suffer. This raised risk-management concerns with the top brass at Goldman, according to the source. When Goldman attempted to pare down its exposure to Falcone, the hedge fund manager told Goldman that it could not withdraw any money because it was subject to a lock-up.

Goldman had also held talks with Falcone to try to influence Harbinger's investment strategies. The firm was concerned that the hedge fund's investments were too concentrated on a few large bets. Falcone refused to change strategies, the source said.

Falcone reportedly has his own theory about Goldman's withdrawal. Max Ableson at the New York Observer reports:

According to a source there, the hedge fund manager believes that Goldman Sachs isn't actually upset about the $113 million withdrawal for taxes, or even his returns, but is simply still miffed that he successfully poached hedge fund star Omar Asali last year.

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