New York State Supreme Court Rules that Liquidating Trustee of Defunct Hedge Fund Lipper Convertibles, L.P. has Right to Claw Back Withdrawals Made to Sylvester Stallone and Other Investors Who Withdrew Their Interests in the Fund at a Time When the Fund’s Assets Were Grossly Overvalued Due to Fraud

Defendants Sylvester Stallone and other individuals and institutional investors invested in Lipper Convertibles, L.P. (Fund), a hedge fund formed by Lipper & Company, L.P.  From January 2001 through January 2002 the defendants withdrew as limited partners from the Fund and received payouts based on the net asset value of the Fund as of the time of their respective withdrawals, as calculated by the Fund’s general partner.  In March 2002, an internal review by the Fund revealed that the Fund’s assets had been dramatically overstated due to the fraudulent actions of its portfolio manager and the apparent neglect or complicity of the Fund’s auditor.  The Fund’s assets were then written down to about 53 percent of their prior values.  The write-downs prompted the Fund’s collapse and its subsequent Court-monitored liquidation.  The Court eventually appointed Richard A. Williamson (Williamson) to act as the Fund’s liquidating trustee in place of the Fund’s general partner.  Among the many lawsuits spawned by the Fund’s collapse were those by Williamson against about sixty Fund investors who had withdrawn prior to the Fund’s collapse and who had received distributions based on the Fund’s fraudulently inflated net asset values.  Williamson sought to claw back distributions made to those investors on the theory that the withdrawing investors had been unjustly enriched at the expense of other innocent investors who had not withdrawn from the Fund.  The eight investors in this action countered by alleging, among other things, that Williamson stood in the shoes of the Fund and that, because the Fund was at fault by virtue of its own fraud, the Fund was not entitled to claw back investor distributions.  The Court ruled that the claw backs were proper.  We outline the background of the lawsuit and summarize the parties’ arguments and the Court’s reasoning.

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