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Published: Saturday, 6/25/2005

Report faults MDL for violating contract

BY JOSHUA BOAK
BLADE STAFF WRITER

MDL Capital Management s decision to leverage billions of dollars for its Bermuda hedge fund caused the Bureau of Workers Compensation to squander $215 million, according to a January, 2005, report released by the bureau.

The report by Callan Associates blamed the failed hedge fund on MDL s mismanagement, arguing that 84 percent of the losses were because of the fact MDL borrowed more money than it should have.

As we re moving forward with the investigation, this is another document from a respected consultant that our contract may have been violated, bureau spokesman Jeremy Jackson said. And those violations led to the losses.

Barry Slotnick, the attorney for MDL Chairman Mark D. Lay, said the direction of the economy was to blame for the losses, not his client.

This is an example of trying to get the public excited, said Mr. Slotnick, who is defending MDL against a lawsuit filed by the state. Had interest rates gone up as expected, Ohio would be a very rich state and would have acclaimed Mark s brilliance.

MDL s primary investment strategy was to short U.S. Treasury bonds that would mature in almost 30 years. The strategy was based on the continued rise in short-term interest rates by the Federal Reserve.

When an investor shorts a bond or stock, he is speculating that the price is too high and will eventually drop. He sells borrowed securities to other investors and agrees to buy those securities back at a later time, when he presumes their price will be lower.

The practice of shorting depends on financial leverage, investing with borrowed money to amplify potential gains.

The report states that the fund s short position was in the hole by $5.6 billion by the end of September, 2004.

At that point, MDL had leveraged 26 times the amount of money the bureau had committed to the fund. The bureau maintains that MDL was only permitted to leverage 1.5 times the fund s principal and broke its contract.

The Callan report concluded that $100 million could have been chopped off the bureau s losses if MDL had only leveraged between 10 and 20 times the fund s capital.

On Aug. 11, 2004, MDL sent the bureau a letter to amend the hedge fund s contract, allowing the fund to have greater leverage.

With respect to U.S Treasury securities leveraging has been and will continue to be significantly higher than 150 percent, it read.

Representatives from the bureau maintain that these changes were never approved.

It was clearly Mark s understanding that he had a right to leverage U.S. Treasuries on behalf of Ohio, Mr. Slotnick said. There is no question that those involved on behalf of the state knew about the leverage and Mark s strategy.

The bureau s chief investment officer, Jim McLean, said the debt was so overwhelming that the bureau added $25 million to the fund in September, 2004, in order to get out of it.

By then, I think the fund was pretty much a disaster, said Mr. McLean, who is on paid administrative leave.

I think the $25 million was simply to allow him the ability to determine what we were going to do. It needed the money to sustain itself.

Contact Joshua Boak at:

jboak@theblade.com

or 419-724-6168.



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