In a partial reversal of a decision from Bayou Group LLC's bankruptcy case, the U.S. District Court for the Southern District of New York reconsidered a controversial ruling that sent shivers down the spines of institutional investors in 2008. In re Bayou Group, LLC, No. 09 Civ. 02577 (S.D.N.Y. Sept. 17, 2010). Specifically, the District Court found the Bankruptcy Court's legal reasoning faulty in deciding that, as a matter of law, all money paid out to redeeming investors within the reachback period could be avoided as a fraudulent conveyance, even though many of these investors had been defrauded themselves. The District Court's recent ruling may do little, however, to help clarify a murky area for institutional investors, leaving them confused as to how they can not only guard against investment risk in unforeseen fraudulent endeavors, but protect themselves from disgorgement of any return they may have innocently received therefrom once a bankruptcy is filed.

The Bayou Bankruptcy In 1996, Sam Israel, Daniel Marino and James Marquez created the Bayou Fund, a hedge fund aimed at attracting large, institutional investors. Although the Fund began losing money from the outset, and never actually turned a profit thereafter, the Fund's managers manufactured the illusion of profitability by issuing fraudulent financial reports claiming extraordinary annual profits. Israel and Marino misappropriated new investor money for their own personal gain, and created a fictional accounting firm to act as an "independent" auditor verifying their financial statements. Additionally, to avoid detection of their fraud, as well as to lend credence to their financial claims, the Fund regularly honored requests from individual investors who wished to redeem their investments. In so doing, the Fund managed to evade investigation, and therefore, legal inquiry.