THIS month a Philadelphia court will hear how a Porsche-driving, stripper-loving hedge-fund manager is accused of hiding $175m (£83m) in losses from wealthy clients. The case is already shining a less-than-flattering light on the secretive world of hedge-fund management and threatens to be a huge embarrassment for two of its biggest players.

For two years receivers for the bust hedge fund, Philadelphia Alternative Asset Management (Paam), have been chasing MF Global, the former brokerage arm of Man Group, the London hedge-fund business, and an arm of UBS, the Swiss bank, through the courts. The broker stands accused of allowing the fund’s manager allegedly to hide his loss-making futures trades with the aid of a former college friend who worked at MF. According to court papers filed in Canada, Paam’s manager, Paul Eustace, admitted that he lied to investors, lost $208m in his hedge funds and stole roughly $2m of client cash. Some of that money was used by the married Eustace to make gifts to his stripper girlfriend worth $1m, including breast-augmentation surgery.

The US Department of Justice filed two fraud charges against Eustace, 42, a Canadian, which include defrauding clients of at least $200m from spring 2001 to June 2005 and misrepresenting the earnings of funds when losses occurred.

So far Eustace is the only one said to have admitted guilt. MF Global is now suing UBS over its role in the collapse and has also counter-sued John Wallace, chairman of Paam and vice-chair-man of the Philadelphia stock exchange, and Ed Gobora, a Paam employee.

The history of disputes involving such big names and deep pockets would suggest a settlement well before a trial. And last month, in its second-quarter results statement, MF Global said: “A definitive settlement agreement is anticipated within the coming weeks.”

MF Global also said settlement and litigation costs were “fully insured” and that the company would obtain “full release and dismissal of the proceedings against it while admitting to no wrongdoing”. MF Global set aside $70m to cover the case.

But sources close to creditors have a different take. With just over a week to go, they say the two sides are still far apart on price. The trial, delayed several times, now looks set for November 27.

Despite the high-profile collapse of some hedge funds, few cases have been brought against their managers or the companies that back them. Given the size of the market, the number of fraud cases is low. Last year the hedge-fund industry attracted record inflows of $126.5 billion, according to Chicago-based Hedge Fund Research, and now manages more than $1,300 billion.

Servicing them has proved a lucrative business for firms like MF Global. But one recent judgment has shown that when a hedge fund does go down it can also be a costly relationship.

Manhattan Investment Fund hid losses of $400m before its collapse in 2000. Its founder, Michael Berger, is on the run from the FBI. In February, a New York court ordered Bear Stearns to pay back nearly $160m it had received in fees from Manhattan Investment Fund because, among other things, it had failed to monitor adequately the activities of the hedge fund. Paam’s creditors are making similar charges against MF Global.

“As financial frauds go, this one was uncomplicated,” the receiver alleges in court documents.

At the heart of the case, the creditors argue, is Thomas Gilmartin, a former senior vice-pres-ident at MF and a college friend of Eustace. Gilmartin, on paid leave from the firm, was key to the alleged scam, his detractors claim. They argue that in helping Eustace, both Gilmartin and MF broke money-laundering rules and financial regulations and were therefore in breach of the contract the fund had with Man, making it liable.

“As trades went sour and losses began to accumulate, the defendants not only hid the massive losses, but also engaged in conduct as reprehensible as it is actionable, including violating federal and state laws, regulations and rules, along with ignoring Man Financial’s internal governing policies and procedures, among other things . . . Hidden, the offshore fund’s losses snowballed into hundreds of millions of dollars,” court papers claim.

As trouble mounted, Eustace and Gilmartin worked together to hide losses by shifting them into a secret account at MF Global to which UBS and Paam employees had no access, according to the receiver. Losses were hidden in an account called the 50 Account. It is alleged that Gilmartin went to lengths to ensure only he and Eustace had access. Phone records reveal Gilmartin told back-office staff to “scratch out” all other names with access to the account except for himself and Eustace.

MF Global and Gilmartin have denied the claims and said the supposedly secret account was never hidden. They argue that the receiver chose the wrong target in going after MF Global.

But as a court case gets closer, all sides must be hoping to reach a settlement. The inner workings of hedge funds tend to be exposed only in times of crisis. This case has already thrown up embarrassing moments for MF and Man, which still owns an 18% stake in the now American-listed company.

This week is the last chance for Stephen Harmelin, Paam’s receiver, to reach a settlement. Failure could cause red faces at UBS, Man and MF Global.

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