The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

Articles By Topic

By Topic: Derivative Suits

  • From Vol. 8 No.44 (Nov. 12, 2015)

    Ninth Circuit’s Misapplication of Derivative Injury Analysis May Encourage Direct Claims Against Hedge Funds

    As courts have lamented, “[d]etermining whether an action is derivative or direct is sometimes difficult.”  Difficult though it may be, this determination is generally an important issue in litigation initiated by investors in hedge funds and other investment companies.  Indeed, the proper characterization of a claim brought by a fund investor against the fund’s adviser and others involved in the management and administration of the fund has many legal consequences, some of which may be outcome determinative.  See “U.S. District Court Holds That Hedge Fund Investors Do Not Have Standing to Bring a Direct, As Opposed to Derivative, Claim against Hedge Fund Auditor PwC,” The Hedge Fund Law Report, Vol. 3, No. 47 (Dec. 3, 2010).  While courts have sought to simplify the direct vs. derivative analysis in recognition of its significance, they continue to be challenged when attempting to apply the proper test.  A noteworthy example is a recent decision by the Ninth Circuit in which the court applied the wrong direct/derivative test and then compounded the error by suggesting that courts should abandon the test whenever faced with claims involving investments in mutual funds.  Although the case involved a mutual fund, it will likely sow confusion in future hedge fund litigation where courts must decide whether a claim is direct or derivative in nature.  In a guest article, Seth Schwartz and Jason Vigna, a partner and a counsel, respectively, at Skadden, analyze the Ninth Circuit’s decision and identify potential ramifications for the hedge fund and alternative mutual fund industry.  For additional insight from Skadden, see “What Do the Investor Advisory Committee’s Recommendations Mean for the Future of Marketing of Hedge Funds to Natural Persons?,” The Hedge Fund Law Report, Vol. 7, No. 40 (Oct. 24, 2014); and our two-part series on Structuring Hedge Funds to Avoid ERISA While Accommodating Benefit Plan Investors: Part One, Vol. 8, No. 5 (Feb. 5, 2015); and Part Two, Vol. 8, No. 6 (Feb. 12, 2015).

    Read Full Article …
  • From Vol. 7 No.39 (Oct. 17, 2014)

    Derivative Actions and Books and Records Demands Involving Hedge Funds

    This article explores the use of derivative actions by investors in hedge funds, which investors may bring against hedge fund managers, and explains that where a fund is organized determines whether an investor can maintain a derivative action.  This article also discusses investor requests for books and records relating to a hedge fund, which typically precede an investor’s derivative action.  The authors of this article are Thomas K. Cauley, Jr. and Courtney A. Rosen, both litigation partners in the Chicago office of Sidley Austin LLP.  See also “Contractual Provisions That Matter in Litigation between a Fund Manager and an Investor,” The Hedge Fund Law Report, Vol. 7, No. 37 (Oct. 2, 2014).

    Read Full Article …
  • From Vol. 6 No.27 (Jul. 11, 2013)

    Hedge Fund Initiates Derivative Suit Against Directors of a Portfolio Company Alleging Self-Dealing in Approving an Acquisition

    Hedge fund managers keen on protecting their funds and their investors from self-dealing or fraud engaged in by directors and officers of portfolio companies or underlying funds must sometimes resort to initiating derivative suits on behalf of such entities against such directors and officers.  For a discussion of derivative suits initiated by investors on behalf of hedge funds, see “In What Circumstances May Hedge Fund Investors Bring Proceedings in the Name of the Fund for a Wrong Committed Against the Fund, When Those in Control of It Refuse to Do So?,” The Hedge Fund Law Report, Vol. 6, No. 3 (Jan. 17, 2013).  A recent example of such a derivative suit was initiated on June 18, 2013, when Omega Overseas Partners, Ltd. (Omega), a hedge fund and a shareholder in investment company Tetragon Financial Group, Ltd. (TFG or the Company), filed an action in the U.S. District Court for the Southern District of New York on behalf of TFG against its officers and directors; its investment manager, Tetragon Financial Management LP; and certain of their affiliates in connection with the board’s decision to approve TFG’s purchase of an investment firm owned and controlled by TFG’s principals and the subsequent share repurchase scheme.  These acts allegedly enriched the principals and TFG management unjustly.  An allegedly “deeply conflicted” TFG board committee approved this two-part scheme, benefitting themselves and TFG principals at the Company’s and its shareholders’ expense.  This article summarizes the primary allegations in Omega’s complaint.

    Read Full Article …
  • From Vol. 6 No.18 (May 2, 2013)

    When Can Hedge Fund Investors Bring Suit Against a Service Provider for Services Performed on Behalf of the Fund?

    A federal district court recently considered whether claims brought by investors in a bankrupt hedge fund against a lender for allegedly aiding and abetting the fund manager’s breach of fiduciary duty and fraud against the hedge fund should be permitted to proceed.  The fundamental question at issue was whether the investors’ claims were direct claims that should be permitted to proceed or derivative claims that should have been brought by the hedge fund and therefore should be dismissed.  For another discussion of derivative suits in the hedge fund context, see “U.S. District Court Holds That Hedge Fund Investors Do Not Have Standing to Bring a Direct, As Opposed to Derivative, Claim against Hedge Fund Auditor PricewaterhouseCoopers LLP,” The Hedge Fund Law Report, Vol. 3, No. 47 (Dec. 3, 2010).  This article summarizes the factual and procedural background of the case as well as the court’s legal analysis and decision.

    Read Full Article …
  • From Vol. 6 No.3 (Jan. 17, 2013)

    In What Circumstances May Hedge Fund Investors Bring Proceedings in the Name of the Fund for a Wrong Committed Against the Fund, When Those in Control of It Refuse to Do So?

    The evolution of the law relating to corporations, and in particular the doctrine of the company as a separate legal person, presented a risk from the earliest times that minority investors might be left without a remedy if those in control of the company breached their trusts or duties and destroyed the value of that investment through mismanagement, self-dealing or other misconduct.  The risk of losing one’s investment in circumstances where there has been corporate wrongdoing has not abated, and in today’s hedge fund universe, the likelihood is that the shareholder will have invested a very substantial amount of capital for a minority position in a fund, the majority of whose directors and whose investment manager and other service providers are based in another country.  There are over 10,000 registered Mutual Funds in the Cayman Islands alone, many of which are directed and managed out of New York or Delaware.  In response to the concern that there is no remedy for the shareholder for such wrongs, many jurisdictions have sought to implement the procedural device of the derivative action as a means of affording substantive relief to investors.  Wherever they are brought, derivative actions have a common theme and a universal aim: the theme is that shareholders are not being heard and cannot take action themselves; the aim is to restore value to the company in which they have invested.  The mechanics for providing this substantive relief vary across the different jurisdictions.  In a guest article, Christopher Russell, David Butler, Michael Swartz and Daniel Cohen compare the mechanics of how hedge fund investors may pursue derivative actions in three different jurisdictions: the Cayman Islands, Delaware and New York.  Russell is a Partner in the Litigation and Insolvency Department of Appleby Cayman, and Butler is a senior Associate in the Department; Swartz is a Partner and Cohen is an Associate at Schulte Roth & Zabel LLP.

    Read Full Article …
  • From Vol. 3 No.47 (Dec. 3, 2010)

    U.S. District Court Holds That Hedge Fund Investors Do Not Have Standing to Bring a Direct, As Opposed to Derivative, Claim against Hedge Fund Auditor PricewaterhouseCoopers LLP

    The U.S. District Court for the Southern District of New York has granted hedge fund auditor PricewaterhouseCoopers LLP (PWC) summary judgment, dismissing the direct fraud claims brought by certain investors in hedge fund Lipper Convertibles, L.P. (Fund).  Following the Fund’s collapse in 2002, Andrew E. Lewin and other Fund investors commenced an action against PWC, the Fund, the Fund’s general partner and certain Fund affiliates and principals, alleging a variety of direct and derivative claims.  At the time of the subject decision, the only surviving claims were the investors’ direct claims against PWC for fraud in the inducement under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 under that Act, common law fraud and negligent misrepresentation.  The investors alleged that they were induced to invest in the Fund by PWC’s false and misleading auditor’s opinions that the Fund’s operations had been audited in accordance with generally accepted auditing standards and that its financial statements were prepared in accordance with generally accepted accounting principles.  The Court granted PWC’s motion for summary judgment, deciding that the investors’ claims were derivative in nature and could not be maintained in a direct action against PWC.  The investors offered no proof that they received less than they bargained for at the time of their respective investments in the Fund.  We summarize the key legal and factual provisions of the Court’s decision.

    Read Full Article …
  • From Vol. 1 No.5 (Mar. 31, 2008)

    New York Court Holds that Limited Partners in Delaware LP Lack Standing to Bring Derivative Claim

    New York Court Holds that Limited Partners in Delaware LP Lack Standing to Bring Derivative Claim

    Read Full Article …