The Hedge Fund Law Report

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

Articles By Topic

By Topic: Fraud

  • From Vol. 10 No.2 (Jan. 12, 2017)

    Hedge Fund Platinum Partners and Principals Face Civil and Criminal Proceedings From SEC and DOJ Over Alleged Fraudulent Valuation Practices and Liquidity Misrepresentations

    The SEC has initiated an enforcement proceeding against Platinum Management (NY) LLC, Platinum Credit Management, L.P. and seven individuals, alleging that they improperly inflated the value of illiquid fund assets, made material misrepresentations to investors to hide the liquidity crisis faced by the firm’s flagship fund and orchestrated a scheme to defraud third-party bondholders of one of the fund’s portfolio companies. In a parallel investigation, the DOJ has brought an eight-count indictment against seven individual defendants for securities fraud, investment adviser fraud and conspiracy. The SEC complaint asserts 11 counts of securities and investment adviser fraud against the defendants. This article discusses the alleged fraudulent conduct, along with the specific SEC and DOJ charges. For additional coverage of the SEC’s recent attention to valuation of illiquid assets, see “SEC Continues to Focus on Insider Trading and Fund Valuation” (Jun. 30, 2016); and “SEC Division Heads Enumerate Enforcement Priorities, Including Conflicts of Interest, Valuation, Performance Advertising and CCO Liability (Part Two of Two)” (May 5, 2016). For more on regulatory concerns over liquidity, see “FSOC Report Focuses on Liquidity, Leverage and Other Risks Facing Hedge Fund and Asset Managers” (Apr. 28, 2016).

    Read Full Article …
  • From Vol. 9 No.41 (Oct. 20, 2016)

    Newly Appointed Chief of New York’s Investor Protection Bureau Describes Its Enforcement of the Martin Act and How Managers Can Avoid Prosecution

    Attorney General Eric T. Schneiderman recently announced the appointment of Katherine C. Milgram as the new Chief of the New York Attorney General’s Investor Protection Bureau (Bureau), part of the Division of Economic Justice. Prior to this appointment, Milgram initially served as Assistant Attorney General, and later as Deputy Chief, of the Bureau. Milgram’s primary responsibility in her new capacity will be to enforce New York’s securities law under the Martin Act. She recently spoke with The Hedge Fund Law Report about the investigative efforts of the Bureau, the type of fund manager behavior it targets and its objectives in pursuing certain types of rewards under the Martin Act. For more on the Martin Act in the hedge fund context, see “New York Court of Appeals Holds That the Martin Act, New York’s ‘Blue Sky’ Law, Does Not Preempt Common Law Claims for Breach of Fiduciary Duty and Gross Negligence” (Jan. 12, 2012); “First Department Decision May Give Aggrieved Hedge Fund Investors an Unexpected and Powerful Avenue of Redress” (Mar. 11, 2011); and “New York Supreme Court Rules That Aris Multi-Strategy Funds’ Suit Against Hedge Funds for Fraud May Proceed, but Negligence Claims Are Preempted Under Martin Act” (Dec. 23, 2009).

    Read Full Article …
  • From Vol. 9 No.35 (Sep. 8, 2016)

    SEC Settlement With Ex-Goldman Head RMBS Trader Highlights Risk That Puffery May Become Misrepresentation When Trading Illiquid Securities

    Hedge fund traders must exercise caution when purchasing hard-to-value securities. Often, the primary source of pricing information comes from the brokers and dealers with which they do business. A recent SEC settlement illustrates a downside of this system: specifically, a broker’s customers can fall prey to an unscrupulous trader who moves beyond sales puffery to outright misrepresentation. The SEC charged that, on at least five occasions in 2011 and 2012, the head of the residential mortgage-backed securities (RMBS) trading desk at Goldman Sachs & Co. (Goldman) misled customers interested in certain RMBS trades, netting Goldman much higher compensation on those trades than the customers thought they were paying. This article summarizes the alleged fraudulent conduct, the SEC’s charges and the terms of the SEC settlement order. For coverage of other enforcement actions involving misrepresentations in sales of RMBS, see “Pricing Information Provided by Brokers to Hedge Fund Managers for Thinly Traded Securities May Not Be Reliable” (Sep. 17, 2015); and “Puffery or Securities Fraud? Litvak Conviction Sheds Light on Permissible Bounds of Bond Sales Talk and the Evidentiary Power of Bloomberg Chats” (Mar. 21, 2014).

    Read Full Article …
  • From Vol. 9 No.30 (Jul. 28, 2016)

    Hedge Fund Managers Must Ensure Portfolios and Valuation Comport With Investor Disclosures or Risk SEC Fraud Action

    The SEC recently commenced an enforcement action against a hedge fund manager, along with its founder and CEO, for misleading investors about the nature and value of the assets held by its funds. The respondents had promised investors that the funds they managed would purchase legal fee receivables from law firms in settled cases. However, the cease-and-desist order instituted by the SEC alleges that a substantial portion of investor money was actually used to purchase receivables from cases that were unsettled or where collection was subject to ongoing litigation risk. The respondents also allegedly manipulated the value of the receivables they purchased. This case highlights the need for hedge fund managers to ensure the investments held in their portfolios, as well as the valuation of those investments, are in line with disclosures made to investors. This article outlines the SEC’s allegations and the relief requested. For more on litigation funding, see “How Can Hedge Funds Mitigate the Risks of Investments in Litigation? An Interview with Kenneth A. Linzer” (Jun. 21, 2012); and “In Turbulent Markets, Hedge Fund Managers Turn to Litigation Funding for Absolute, Uncorrelated Returns” (Jun. 24, 2009).

    Read Full Article …
  • From Vol. 9 No.28 (Jul. 14, 2016)

    Caspersen Fraud Reminds Institutional Investors to Look Beyond a Hedge or Private Equity Fund’s Name to Verify Its Structure and Management

    Unlike alternative mutual funds and other registered investment companies, hedge and private equity funds are not subject to regulations regarding what they can be named. See “Hedge Fund Names: What a Hedge Fund Manager Should Do Before It Starts Using a Name” (Mar. 16, 2012). It is therefore incumbent on investors to look beyond the name of any fund in which it is considering investing and conduct due diligence to verify the actual structure, sponsorship and management of the entity. The recent guilty plea of Andrew Caspersen is a reminder of this and the peril faced by institutional and other sophisticated investors that fail to conduct this necessary due diligence. Using confusingly named entities and bank accounts, Caspersen, an investment principal and partner in two alternative asset management firms, perpetrated a scheme of securities and wire fraud. This article summarizes the DOJ’s criminal complaint against Caspersen and details several lessons for institutional investors to protect themselves from fraud. For another scheme involving the sale of bogus promissory notes in the hedge fund industry, see “Federal Judge Approves Settlement Agreements Arising out of Marc Dreier’s Criminal Fraud; Hedge Fund Victims ‘Squabble’ Over Proposed Recovery” (Feb. 17, 2010). For more on conducting due diligence, see “Why Should Hedge Fund Investors Perform On-Site Due Diligence in Addition to Remote Gathering of Information on Managers and Funds?”: Part One (Jan. 29, 2015); Part Two (Feb. 5, 2015); and Part Three (Feb. 12, 2015).

    Read Full Article …
  • From Vol. 8 No.49 (Dec. 17, 2015)

    Proper Use of Advisory Committees by Private Fund Managers May Mitigate Conflicts of Interest

    Investment adviser conflicts of interest remain a key focus of SEC scrutiny.  See “SEC’s Rozenblit Discusses Operations and Priorities of the Private Funds Unit,” The Hedge Fund Law Report, Vol. 8, No. 37 (Sep. 24, 2015); and “Conflicts Remain an Overarching Concern for the SEC’s Asset Management Unit,” The Hedge Fund Law Report, Vol. 8, No. 10 (Mar. 12, 2015).  In another example of such scrutiny, the SEC recently settled charges that a private equity fund adviser and its principals violated the anti-fraud provisions of the Investment Advisers Act by making loans to portfolio companies, causing different funds to invest in the same companies at different priority levels and violating investment concentration restrictions, in each case without disclosing those transactions to, or securing the consent of, the affected funds’ investor advisory boards.  This article summarizes the alleged misconduct and violations, the adviser’s remedial efforts and the terms of the settlement.  For an overview of the types of conflicts faced by private fund managers, see “RCA Panel Highlights Conflicts of Interest Affecting Fund Managers,” The Hedge Fund Law Report, Vol. 8, No. 26 (Jul. 2, 2015).  For conflicts arising out of allocation of expenses, see, e.g., “Specific Disclosure Before Charging Legal Expenses to Funds May Help Investment Advisers Avoid SEC Scrutiny,” The Hedge Fund Law Report, Vol. 8, No. 45 (Nov. 19, 2015); and “Recommended Actions for Hedge Fund Managers in Light of SEC Enforcement Trends,” The Hedge Fund Law Report, Vol. 8, No. 41 (Oct. 22, 2015).

    Read Full Article …
  • From Vol. 8 No.40 (Oct. 15, 2015)

    Appropriately Crafted Disclosure of Conflicts of Interest Can Mitigate the Likelihood of an Enforcement Action Against an Investment Adviser

    The SEC recently filed an enforcement action against an investment adviser and its owner for fraud, self-dealing, conflicts of interest and other violations.  Conflicts of interest remain near the top of the SEC’s enforcement agenda.  See, e.g., “SEC’s Rozenblit Discusses Operations and Priorities of the Private Funds Unit,” The Hedge Fund Law Report, Vol. 8, No. 37 (Sep. 24, 2015); and “Conflicts Remain an Overarching Concern for the SEC’s Asset Management Unit,” The Hedge Fund Law Report, Vol. 8, No. 10 (Mar. 12, 2015).  The SEC charges that the defendants caused clients and funds they managed to invest in companies in which the owner had a financial interest without revealing the interest or the owner’s receipt of compensation from those companies.  It also charges that they engaged in undisclosed principal transactions, diverted client income, ignored investment guidelines, violated the custody rule and failed to update Form ADV.  The SEC seeks an injunction against the defendants, disgorgement of ill-gotten gains and civil penalties.  This article summarizes the SEC’s allegations and claims for relief.  For more on disclosure, see “RCA Panel Discusses Pay to Play Rules, GIPS Compliance, Disclosures, Risk Assessments and ERISA Proposals,” The Hedge Fund Law Report, Vol. 8, No. 27 (Jul. 9, 2015).

    Read Full Article …
  • From Vol. 8 No.36 (Sep. 17, 2015)

    Pricing Information Provided by Brokers to Hedge Fund Managers for Thinly Traded Securities May Not Be Reliable

    The SEC has commenced a civil enforcement action in the U.S. District Court for the Southern District of New York against three former traders who were working at a broker-dealer.  The SEC asserts that, in connection with their purchases and sales of residential mortgage-backed securities (RMBS) and manufactured housing asset-backed securities, the defendants repeatedly lied to customers about the prices that potential sellers were asking for such securities; about the bids that potential buyers were making for such securities; and about the compensation that the broker-dealer would receive for brokering trades.  The defendants have also been indicted on criminal securities and wire fraud charges in the U.S. District Court for the District of Connecticut.  The case is a reminder that hedge fund managers should think twice before relying on pricing information provided by brokers with regard to thinly traded securities.  This article summarizes the allegations set forth in the SEC complaint and the relief sought by the SEC.  For discussion of another action involving alleged misrepresentations by a broker in connection with sales of RMBS, see “Puffery or Securities Fraud? Litvak Conviction Sheds Light on Permissible Bounds of Bond Sales Talk and the Evidentiary Power of Bloomberg Chats,” The Hedge Fund Law Report, Vol. 7, No. 11 (Mar. 21, 2014).

    Read Full Article …
  • From Vol. 8 No.30 (Jul. 30, 2015)

    Employees of Hedge Fund Managers May Be Liable for Failing to Prevent Fraud

    An investment management firm, along with its affiliate, has filed a claim against its former chief financial officer (CFO), who unwittingly disclosed the firm’s online banking security details to a fraudulent caller, enabling illegitimate transfers from the firm’s bank accounts.  The investment management firm claims that the CFO acted negligently and in breach of his contractual, tortious and fiduciary duties in failing to protect assets in corporate bank accounts.  The CFO, who believed he was providing security details to a member of the anti-fraud team of the investment manager’s private bank, denies failing to uphold the required standard of care, asserting that he was acting honestly, in what he reasonably and genuinely believed to be the best interests of his employer.  This article examines the allegations in the claim, as well as the rebuttals raised by the CFO in his defense.  In addition, the claim raises a number of questions and brings to the fore various issues of relevance to hedge fund managers and their staff, which are discussed in this article.  For another case where employees of a hedge fund manager were held liable for fraudulent actions, see “U.K. Appellate Court Holds That Hedge Fund Manager Employees May Be Personally Liable for Unreasonably Relying on the Representations of a Hedge Fund Manager Principal Regarding Performance and Portfolio Composition,” The Hedge Fund Law Report, Vol. 6, No. 9 (Feb. 28, 2013).

    Read Full Article …
  • From Vol. 8 No.24 (Jun. 18, 2015)

    Public Pension Plan Investments May Increase the Risk That Hedge Fund Managers May Breach Fiduciary Duties

    Pension funds are significant sources of assets for private fund managers.  Hedge fund managers seeking investments from pension funds face a number of practical and legal concerns – including the possible need to register as a municipal advisor, the complex ERISA regime, pay to play rules and dealing with pension consultants – that may not otherwise arise with respect to individuals or other types of institutional investors.  In addition, as exemplified by a recent SEC order against an investment adviser and two of its principals, public pension plan investors may increase the range of responsibilities for hedge fund managers that, if not adequately discharged, can lead to breach of those managers’ fiduciary duties, with potential serious consequences.  In the order, the SEC claims that the respondents engaged in fraudulent conduct by soliciting several state public pensions to invest in one of their alternative investment fund of funds, even though the fund did not satisfy the criteria established under applicable state law for alternative investments by public pension funds.  This article summarizes the relevant provisions of state law, the alleged misconduct by the respondents and the SEC’s charges.  For more on public pension funds, see “Why and How Do Corporate and Government Pension Plans, Endowments and Foundations Invest in Hedge Funds?,” The Hedge Fund Law Report, Vol. 6, No. 14 (Apr. 4, 2013).

    Read Full Article …
  • From Vol. 8 No.23 (Jun. 11, 2015)

    Liquidators of Cayman Islands Funds Sue Bank in Bid to Claw Back $80 Million

    The liquidators of a Cayman Islands master fund and feeder fund (together, the Funds) recently commenced an adversary proceeding in the U.S. Bankruptcy Court for the Southern District of New York seeking to recover more than $80 million from one of their financing banks under the fraudulent conveyance laws of both the Cayman Islands and New York State.  In the complaint, the Funds allege that the defendant bank played a “pivotal role” in the alleged fraud perpetrated by the manager of the fund and its founder and principal, which was the subject of a 2010 SEC enforcement action.  This article summarizes the background facts and the plaintiffs’ allegations against the defendant bank.  For other cases involving Cayman liquidators that sought to use Chapter 15 proceedings, see “Delaware Bankruptcy Court Recognizes Cayman Islands Proceeding as ‘Foreign Main Proceeding’ Under Chapter 15 of the U.S. Bankruptcy Code,” The Hedge Fund Law Report, Vol. 3, No. 6 (Feb. 11, 2010); and “Cayman Islands Liquidations of Failed Bear Stearns Hedge Funds Denied Access to U.S. Bankruptcy Court,” The Hedge Fund Law Report, Vol. 1, No. 13 (May 30, 2008). 

    Read Full Article …
  • From Vol. 8 No.15 (Apr. 16, 2015)

    SEC Summary Judgment Emphasizes the Importance of Disclosure of and Client Consent to Cross Trades and Principal Transactions

    A recent decision by the U.S. District Court for the Eastern District of New York granting the SEC’s motion for partial summary judgment against an affiliated registered investment adviser and broker-dealer and their principal emphasizes the importance the SEC places on obtaining client consent to cross trades among clients and principal transactions with client accounts in advance of such transactions.  For recent resolution of another case brought by the SEC against a manager involving inter-fund transactions, see “SEC Settlement Emphasizes the Importance – and Limits – of Fund and Transaction Disclosure,” The Hedge Fund Law Report, Vol, 8, No. 13 (Apr. 2, 2015).  For more on transactions among hedge funds, see “Katten Forum Identifies Best Practices for Hedge Fund Managers Regarding Best Execution, Soft Dollars, Principal Trades, Agency Cross Trades, Cross Trades and Trade Errors,” The Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014).  For more on transactions between hedge fund managers and funds, see “When and How Can Hedge Fund Managers Engage in Transactions with Their Hedge Funds?,” The Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).  This article provides a detailed discussion of the decision, then highlights the implications for the hedge fund industry arising out of the decision.

    Read Full Article …
  • From Vol. 8 No.14 (Apr. 9, 2015)

    SEC Fraud Charges Against Lynn Tilton, So-Called “Diva of Distressed,” Confirm the Agency’s Focus on Valuation and Conflicts of Interest

    On March 30, 2015, the SEC announced the commencement of an enforcement action against Lynn Tilton, the so-called “Diva of Distressed,” and several entities she controls, arising out of the alleged overvaluation of distressed debt in the collateralized loan obligations (CLOs) they advise.  The SEC charges that Tilton improperly valued the loans owned by those CLOs, resulting in her receipt of nearly $200 million in compensation that she was not entitled to receive.  She also allegedly certified false and misleading financial statements for those CLOs and failed to disclose and obtain investor consent to the conflict of interest posed by her discretionary valuation method.  This article summarizes the SEC’s allegations and its specific charges.  For more on CLOs, see “Private Investment Funds Investing in CLO Equity and CLO Warehouse Facilities,” The Hedge Fund Law Report, Vol. 7, No. 18 (May 8, 2014).

    Read Full Article …
  • From Vol. 7 No.33 (Sep. 4, 2014)

    U.K. Superior Court Upholds FCA Industry Ban and Steep Penalty Imposed on Principal of Hedge Fund Manager Dynamic Decisions Capital

    The Upper Tribunal, Tax and Chancery Chamber (Court), a U.K. Superior Court of Record, recently affirmed, with minor modification, a decision notice by the Financial Conduct Authority (FCA) to withdraw approval from, and to impose an industry ban and a record financial penalty on, a hedge fund manager who used bonds of questionable provenance to conceal his fund’s substantial trading losses.  On bond trading, see “Puffery or Securities Fraud?  Litvak Conviction Sheds Light on Permissible Bounds of Bond Sales Talk and the Evidentiary Power of Bloomberg Chats,” The Hedge Fund Law Report, Vol. 7, No. 11 (Mar. 21, 2014).  The Court’s decision, involving Alberto Micalizzi and DD Growth Premium Master Fund, provides insight on the legal standards involved in U.K. investment adviser fraud cases and the penalties that the FCA may impose.  See also “FSA Bans Hedge Fund Firm Dynamic Decisions and Imposes Highest-Ever Fine on an Individual in a Non-Market Abuse Case Against CEO Alberto Micalizzi,” The Hedge Fund Law Report, Vol. 5, No. 24 (Jun. 14, 2012).

    Read Full Article …
  • From Vol. 7 No.32 (Aug. 28, 2014)

    SEC Action Against Custodian to Fraudulent Hedge Fund Manager Limns the Spectrum of Service Provider Culpability

    The SEC recently charged a brokerage firm and its president (Defendants) with helping a hedge fund manager conceal trading losses from investors and misappropriate investor funds.  According to the SEC, the Defendants were necessary to the success of the fraud, and the Defendants received payments from the manager for participating in his scheme.  If the SEC’s factual allegations are accurate, then the Defendants were knowingly complicit in the underlying fraud, and thus effectively participants.  But what if the Defendants were not knowingly complicit but rather received “storm warnings” of the fraud, or identified red flags then did nothing, or not enough?  Or what if red flags could have been uncovered with reasonable investigation, but the Defendants failed to uncover them?  This article describes the factual and legal allegations in this matter, and briefly considers the foregoing questions.  For a stark illustration of the challenges facing a service provider to a fraudulent hedge fund manager, see “Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011).

    Read Full Article …
  • From Vol. 7 No.11 (Mar. 21, 2014)

    Puffery or Securities Fraud?  Litvak Conviction Sheds Light on Permissible Bounds of Bond Sales Talk and the Evidentiary Power of Bloomberg Chats

    On March 7, 2014, a senior Jefferies & Co., Inc. (Jefferies) employee, Jesse C. Litvak, was convicted by a Connecticut jury of 15 counts of federal securities fraud and other violations arising out of the sales tactics he used in selling bonds.  Litvak was a licensed broker who was employed as a senior trader and managing director at Jefferies.  He specialized in trading residential mortgage-backed security (RMBS) bonds.  He sold RMBS bonds to customers that included U.S. government-sponsored Public-Private Investment Funds, which were established in 2009 and 2010 under the Troubled Asset Relief Program.  A March 12, 2014 panel discussion organized by the law firm Richards Kibbe & Orbe LLP (RKO) addressed the fraud allegations, the legal arguments adduced by the prosecution and defense and the lessons from Litvak’s conviction.  The panel featured RKO partners Lee Richards III, Daniel Stein and David Massey, all former Assistant U.S. Attorneys, and Michael Mann, a former SEC Director of the Office of International Affairs.  This article summarizes the main points from the discussion, which should inform interactions between hedge fund managers that trade fixed income securities and their brokers.  For additional insight from RKO partners, see “Succession Planning Series: Selling a Hedge Fund Founder’s Interest to an Outside Investor (Part Two of Two),” The Hedge Fund Law Report, Vol. 7, No. 2 (Jan. 16, 2014); “Convertible Preferred Stock: How Preferred Is It? (Part Two of Two),” The Hedge Fund Law Report, Vol. 7, No. 1 (Jan. 9, 2014); and “An Examination of Exit Rights for Hedge Funds Making Non-Controlling Private Equity Investments,” The Hedge Fund Law Report, Vol. 6, No. 28 (Jul. 18, 2013).

    Read Full Article …
  • From Vol. 6 No.40 (Oct. 17, 2013)

    Criminal and Civil Actions against Purported Investment Adviser Underscore the Imperative of Candor during SEC Examinations

    On September 13, 2013, the SEC charged Frederick D. Scott, owner of a New York-based investment advisory firm, with defrauding investors and falsely claiming he managed $3.7 billion in assets.  On the same day, in a parallel criminal action brought in the Eastern District of New York, Scott pled guilty to making materially false statements to the SEC during the course of an investigation and conspiring to commit wire fraud.  Scott, who will be sentenced later this year, faces up to five years’ imprisonment on the false statements charge alone.  The joint actions against Scott highlight the government’s commitment to civilly and criminally charging individuals who defraud investors and lie during the course of an SEC examination or investigation.  See “Is This an Inspection or an Investigation? The Blurring Line Between Examinations of and Enforcement Actions Against Private Fund Managers,” The Hedge Fund Law Report, Vol. 5, No. 13 (Mar. 29, 2012).  In preparing for investigations, investment advisers must ensure that all personnel who communicate with the SEC are well versed in the potential repercussions of withholding material information or lying to examiners.  This article summarizes the civil and criminal charges against Scott and his subsequent plea deal, based on allegations contained in the SEC complaint, the criminal information and a Debevoise & Plimpton LLP Client Update describing the case and Scott’s plea deal.

    Read Full Article …
  • From Vol. 6 No.34 (Aug. 29, 2013)

    U.S. District Court Upholds Hedge Fund’s Security Interest in Marc Dreier’s Art Collection

    Disgraced attorney Marc Dreier swindled his victims out of nearly $400 million in a scheme involving the issuance of fraudulent promissory notes.  Elliott International L.P. and Elliott Associates, L.P. (together, Elliott), were among Dreier’s largest victims, having purchased $100 million of fake notes in Dreier’s fraud.  As part of that transaction, Dreier had granted Elliott a security interest in eighteen works of art by well-known artists such as Damien Hirst, Roy Lichtenstein, Mark Rothko and Andy Warhol (Artwork) in Dreier’s personal collection.  Following his fraud conviction, certain of Dreier’s assets – including the Artwork – were forfeited to the U.S. government.  Elliott sought to recover the Artwork on the ground that its security interest in the Artwork gave it priority over Dreier’s other victims seeking restitution from Dreier’s estate.  Not surprisingly, those other victims objected.  The U.S. District Court for the Southern District of New York (Court) recently ruled on whether Elliott was, in fact, entitled to the Artwork by virtue of the security interest that Dreier had granted.  The Court’s decision is relevant both to hedge funds that hold security interests in connection with investments and to funds that seek restitution out of forfeited assets in the event of fraud.  This article summarizes the facts of the dispute and the Court’s legal analysis.  Dreier’s victims have also been sparring in bankruptcy court.  See “Federal Judge Approves Settlement Agreements Arising out of Marc Dreier’s Criminal Fraud; Hedge Fund Victims ‘Squabble’ Over Proposed Recovery,” The Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17, 2010).  One victim, Fortress Credit Corp., has tried unsuccessfully to recover from Dreier’s outside counsel.  See “Dismissal of Fortress’ Complaint Against Dechert Illustrates the Limits of a Hedge Fund Manager’s Ability to Rely on a Legal Opinion Issued by a Law Firm of Which It Is Not a Client,” The Hedge Fund Law Report, Vol. 4, No. 44 (Dec. 8, 2011); and “Affiliates of Hedge Fund Manager Fortress Investment Group Sue Dechert Over Opinion Letter Endorsing Marc Dreier,” The Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009).

    Read Full Article …
  • From Vol. 6 No.33 (Aug. 22, 2013)

    Important Implications and Recommendations for Hedge Fund Managers in the Aftermath of the SEC’s Settlement with Philip A. Falcone and Harbinger Entities

    A new era in SEC enforcement has begun.  On August 19, 2013, Philip A. Falcone, Harbinger Capital Partners LLC (Harbinger) and other Harbinger entities agreed to a consent settling SEC charges.  The charges related to: (1) an improper loan effected between Falcone and the Harbinger Capital Partners Special Situations Fund; (2) improper arrangements between Falcone, Harbinger Capital Partners Fund I and various large fund investors that provided such investors with undisclosed preferential redemption terms; and (3) improper trading in the distressed high yield bonds issued by Canadian manufacturing company MAAX Holdings, Inc.  The groundbreaking settlement affirms the SEC’s commitment to extracting admissions of wrongdoing as a condition of settlement in select cases involving egregious conduct or significant harm to investors, which stands in direct contrast to its previous policy of allowing defendants to “neither admit nor deny the charges” in settlement agreements.  The settlement has broad implications for hedge fund managers, and it behooves such managers to understand how to address such issues.  This article describes the facts as admitted by the defendants; outlines the sanctions agreed to by the defendants; highlights important issues that hedge fund managers must address in light of the settlement agreement and the SEC’s new settlement policy; and provides practical recommendations for addressing such issues.  For a discussion of the SEC’s enforcement action initiated against the defendants, see “SEC Charges Philip A. Falcone, Harbinger Capital Partners and Related Entities and Individuals with Misappropriation of Client Assets, Granting of Preferential Redemptions and Market Manipulation,” The Hedge Fund Law Report, Vol. 5, No. 26 (Jun. 28, 2012).

    Read Full Article …
  • From Vol. 6 No.15 (Apr. 11, 2013)

    Does the U.S. Commodity Exchange Act Apply to Investments in Non-U.S. Commodity Funds?

    A Federal District Court recently considered the extent of extraterritorial application of the Commodity Exchange Act to an investment in allegedly fraudulent non-U.S. funds that invest in commodities, among other assets.  See also “How Can Offshore Hedge Funds Ensure That Section 10(b) Will Apply to Their Transactions in Securities Not Listed on U.S. Exchanges,” The Hedge Fund Law Report, Vol. 5, No. 13 (Mar. 29, 2012); and “Second Circuit Clarifies When Offshore Hedge Funds Can Make Section 10(b) Securities Fraud Claims in Connection with ‘Domestic Transactions’ with Conduct and Effects in the United States,” The Hedge Fund Law Report, Vol. 5, No. 11 (Mar. 16, 2012).

    Read Full Article …
  • From Vol. 6 No.10 (Mar. 7, 2013)

    SEC Charges Hedge Fund Manager and its Principals with Defrauding Investors in Connection With an Undisclosed Restructuring of Feeder Funds to Favor Largest Investor

    A recently filed SEC enforcement action – along with a criminal indictment based on the same facts – demonstrates the continued focus of regulators and prosecutors on undisclosed preferential treatment of certain hedge fund investors.  See, e.g., “SEC Charges Philip A. Falcone, Harbinger Capital Partners and Related Entities and Individuals with Misappropriation of Client Assets, Granting of Preferential Redemptions and Market Manipulation,” The Hedge Fund Law Report, Vol. 5, No. 26 (Jun. 28, 2012).

    Read Full Article …
  • From Vol. 6 No.9 (Feb. 28, 2013)

    U.K. Appellate Court Holds That Hedge Fund Manager Employees May Be Personally Liable for Unreasonably Relying on the Representations of a Hedge Fund Manager Principal Regarding Performance and Portfolio Composition

    The best hedge fund managers are often great salespeople, and a good bit of their sales efforts are often directed internally – in particular, at persuading non-investment professionals to buy into their view of the world.  This is fine so long as that view is compelling and legitimate.  But this becomes problematic for all involved when that view is fraudulent.  A recent U.K. appellate court decision indicates that employees of hedge fund managers may be liable in cases where they accept at face value – and relay to third parties – representations from a manager principal that they knew or should have known to be false.  “He told me so” is not a valid defense to a suit for negligence; and employees with limited authority can be hit with effectively unlimited liability.

    Read Full Article …
  • From Vol. 6 No.9 (Feb. 28, 2013)

    Can a Hedge Fund That Invested in a Ponzi Scheme Recover from a Bank Where the Architect of the Scheme Maintained Accounts?

    A U.K. trial court recently handed down a decision in a suit brought by a hedge fund manager and its principal against a bank and one of its relationship managers for damages resulting from approximately £15.5 million in losses suffered in an alleged Ponzi scheme in which they invested that maintained accounts at the bank.  The plaintiffs claimed that the bank and the relationship manager, which handled several accounts used in the Ponzi scheme, were liable for negligence, deceit and other misconduct and for failing to reveal information about the accounts to the plaintiffs.  Importantly, the court’s decision in this case highlights the extent to which a bank and its employees are obligated to discover and disclose information about their customers’ accounts to hedge fund managers.  This article summarizes the factual background, legal analysis and decision in this case.

    Read Full Article …
  • From Vol. 5 No.37 (Sep. 27, 2012)

    Second Circuit Upholds Dismissal of Hedge Fund Investors’ Securities Fraud and Negligence Suits Against Fund Auditors, KPMG and Ernst & Young, Based on their Alleged Failure to Detect Madoff Fraud

    Individuals and hedge funds that invested in certain Bernard L. Madoff feeder funds that were managed by Tremont Group Holdings, Inc. and its affiliates (Tremont) initiated lawsuits in the U.S. District Court for the Southern District of New York (District Court) against Tremont and accounting firms KPMG LLP, KPMG (Cayman) and Ernst & Young LLP (together, Auditors).  The plaintiffs claimed that the Auditors were liable for securities fraud, common law fraud, negligence and breach of fiduciary duty arising out of their audit of certain Tremont funds that invested with Bernard L. Madoff Investment Securities, LLC (Madoff) and their failure to detect the Madoff fraud.  The District Court granted the Auditors’ motion to dismiss the complaint for failure to state a claim against the Auditors.  The U.S. Court of Appeals for the Second Circuit has upheld that dismissal.  This article summarizes the investors’ claims as well as the Court of Appeals’ decision and reasoning.

    Read Full Article …
  • From Vol. 5 No.35 (Sep. 13, 2012)

    Fund Misrepresentations Inducing Investment: Claims and Remedies Available to Fund Investors and Protections Available to Promoters, Fund Managers and Directors

    False statements inducing initial or continued investment in Cayman funds are relatively rare, but if they do occur, the financial consequences are often catastrophic for the misled investor and present him with a dilemma – whether to pull out and try to recoup the investment, or to stay in, try to recover what losses are retrievable and take whatever benefits there may be down the line.  Although the decision may be easy enough as a matter of choice in principle, a number of thorny legal issues may arise, such as the right to rescind an allotment of shares, derivative claims and the bar on recovery of reflective loss.  For promoters, managers and directors seeking to avoid such claims, the issue is how to protect themselves from accusations of misleading statements about the fund, and from consequent liability for such statements.  In a guest article, Christopher Russell and Jeremy Snead of Appleby (Cayman) discuss the claims and remedies available to misled fund investors and the protections available to promoters, fund managers and directors that seek to protect themselves from allegations of misrepresentation.

    Read Full Article …
  • From Vol. 5 No.35 (Sep. 13, 2012)

    SEC Obtains Consent Judgment against Fund of Funds Manager Gary R. Marks Based on Charges that He Made Unsuitable Investment Recommendations; Misrepresented Fund Investment Diversification; and Failed to Disclose Material Fund Information

    The Securities and Exchange Commission (SEC) has charged Gary R. Marks, who managed four funds of funds through Sky Bell Asset Management, LLC (Sky Bell), with violating various provisions of the Investment Advisers Act of 1940 and the Securities Act of 1933 by recommending unsuitable investments to his clients; misrepresenting that those funds’ returns were not correlated with each other; and failing to disclose material financial information about those funds.  Marks has consented to the entry of a judgment against him that enjoins him from future securities laws violations and requires him to disgorge profits and pay a civil penalty.  This article summarizes the events that led to the SEC’s enforcement action; the SEC’s specific charges; and the resolution of those charges.

    Read Full Article …
  • From Vol. 5 No.32 (Aug. 16, 2012)

    Tyrus Capital Settles Securities Fraud Case with Brazilian Securities Regulator

    Monaco-based hedge fund management firm Tyrus Capital LLP (Tyrus Capital) recently settled a case with Comissão de Valores Mobiliários (CVM), the Brazilian securities regulatory authority.  Tyrus Capital and the CVM reached the settlement in connection with CVM’s investigation into an alleged “fraudulent operation” relating to trading of shares of a Brazilian telecommunications company, GVT (Holding) S.A. (GVT), while Tyrus Capital allegedly possessed nonpublic information about Vivendi’s plans to acquire a controlling stake in GVT.  This article discusses the background of Tyrus Capital, its trading in GVT shares and the details of its settlement with the CVM.  In addition, to provide insight into the thinking and process of the CVM for English-speaking readers, The Hedge Fund Law Report specially commissioned translations of two primary documents: (1) minutes of the CVM’s July 3, 2012 board meeting, at which the Tyrus Capital settlement was discussed (along with many other matters); and (2) an approved commitments document memorializing the CVM’s approval of the Tyrus Capital settlement.  These documents are valuable for U.S., U.K. and other English-speaking hedge fund managers that have or are contemplating investments in Brazil, and who therefore wish to enrich their understanding of the thinking, procedure and enforcement approach of the primary Brazilian securities regulator.  Both documents are included as links in this article.

    Read Full Article …
  • From Vol. 5 No.29 (Jul. 26, 2012)

    Hedge Fund of Funds Manager Principal Charged with Securities Fraud and Wire Fraud over Misrepresentations Concerning Fund Performance and Investment Due Diligence

    The U.S. has filed a seven-count indictment against Chetan Kapur, the sole principal of hedge fund manager Lilaboc, LLC, d/b/a ThinkStrategy Capital Management, LLC (ThinkStrategy).  Kapur is charged with securities, investment adviser and wire fraud arising out of his alleged misrepresentations to investors regarding due diligence of fund investments and fund performance.  Kapur and ThinkStrategy have previously settled civil charges brought by the SEC in connection with the same matters.  See “Private Lawsuits Against Hedge Fund Managers Can Be Important Sources of Examination and Enforcement ‘Leads’ for the SEC,” The Hedge Fund Law Report, Vol. 4, No. 42 (Nov. 23, 2011).  This article summarizes the background in this case (including a discussion of the enforcement action initiated by the SEC and the private investor suit brought against Kapur and ThinkStrategy) and outlines the criminal charges levied against Kapur.  See also “Federal Court Decision Holds That a Fund of Funds Investor May Sue a Fund of Funds Manager That Fails to Perform Specific Due Diligence Actions Promised in Writing and Orally,” The Hedge Fund Law Report, Vol. 4, No. 27 (Aug. 12, 2011).

    Read Full Article …
  • From Vol. 5 No.27 (Jul. 12, 2012)

    U.K. High Court of Justice Finds Magnus Peterson Liable for Fraud in Collapse of Hedge Fund Manager Weavering Capital and Weavering Macro Fixed Income Fund

    In 1998, defendant Magnus Peterson formed hedge fund manager Weavering Capital (UK) Limited (WCUK).  He served as a director, chief executive officer and investment manager.  One fund managed by WCUK, the open-end Weavering Macro Fixed Income Fund Limited (Fund), collapsed in the midst of the 2008 financial crisis.  Peterson was accused of disguising the Fund’s massive losses by entering into bogus forward rate agreements and interest rate swaps with another fund that he controlled.  In March 2009, the Fund suspended redemptions and went into liquidation when it could not meet investor redemption requests.  At that time, WCUK went into administration (bankruptcy).  WCUK’s official liquidators, on behalf of WCUK, brought suit against Peterson, his wife, certain WCUK employees and directors and others, seeking to recover damages for fraud, negligence and breach of fiduciary duty and seeking to recover certain allegedly improper transfers of funds by Peterson.  After a lengthy hearing, the U.K. High Court of Justice, Chancery Division (Court), has allowed virtually all of those claims, ruling that Peterson did indeed engage in fraud.  In a separate action, the Fund’s official liquidators recovered damages from Peterson’s brother, Stefan Peterson, and their stepfather, Hans Ekstrom, who served as Fund directors, based on their willful failure to perform their supervisory functions as directors.  See “Cayman Grand Court Holds Independent Directors of Failed Hedge Fund Weavering Macro Fixed Income Fund Personally Liable for Losses Due to their Willful Failure to Supervise Fund Operations,” The Hedge Fund Law Report, Vol. 4, No. 31 (Sep. 8, 2011).  This article summarizes the factual background and the Court’s legal analysis in the liquidators’ action against Peterson and others.

    Read Full Article …
  • From Vol. 5 No.26 (Jun. 28, 2012)

    SEC Charges Philip A. Falcone, Harbinger Capital Partners and Related Entities and Individuals with Misappropriation of Client Assets, Granting of Preferential Redemptions and Market Manipulation

    On June 26, 2012, the SEC filed three separate complaints relating to securities law violations allegedly committed by Philip A. Falcone, his investment advisory firm, Harbinger Capital Partners LLC (Harbinger) and other entities and individuals.  In the first complaint, the SEC charged Falcone, Harbinger and Peter Jenson, a former Managing Director and Chief Operating Officer of Harbinger, with violations of the federal securities laws in relation to the misappropriation of client assets (through the making of a $113.2 million loan from a fund managed by Harbinger to Falcone to pay his personal taxes) and the granting of undisclosed preferential redemption rights to certain investors.  See “Key Legal Considerations in Connection with Loans from Hedge Funds to Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 3, No. 28 (Jul. 15, 2010).  In the second complaint, the SEC charged Falcone, Harbinger Capital Partners Offshore Manager, L.L.C. and Harbinger Capital Partners Special Situations GP, L.L.C. with engaging in an illegal short squeeze to manipulate bond prices.  In the third complaint, the SEC charged Harbert Management Corporation, HMC-New York, Inc. and HMC Investors, LLC with control person liability in relation to the alleged market manipulation described in the second complaint.  Separately, the SEC issued an order settling claims with Harbinger related to violations of Rule 105 under Regulation M.  This article details the charges levied by the SEC in the three complaints and details the terms of the settlement with Harbinger related to the Rule 105 violations.

    Read Full Article …
  • From Vol. 5 No.24 (Jun. 14, 2012)

    FSA Bans Hedge Fund Firm Dynamic Decisions and Imposes Highest-Ever Fine on an Individual in a Non-Market Abuse Case Against CEO Alberto Micalizzi

    On May 29, 2012, the UK Financial Services Authority (FSA) published a Decision Notice explaining the facts and rationale for the largest fine in a non-market abuse case, £3 million, against Alberto Micalizzi, Chief Executive Officer of Dynamic Decisions Capital Management Ltd (DDCM), a hedge fund management firm based in London and Milan. In a related case decided in November 2011, the FSA fined Dr. Sandradee Joseph, DDCM’s Compliance Officer, £14,000 (US $21,757), and banned her from performing any significant influence function in regulated financial services.  In that matter, the FSA found that Joseph failed to investigate or act on investors’ concerns over potentially improper activity at DDCM.  See “Recent FSA Settlement Helps Define the Scope of Potential Liability of the Chief Compliance Officer of a U.K. Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 4, No. 43 (Dec. 1, 2011).  The cases against Micalizzi and Joseph are part of a series of recent vigorous enforcement actions by the FSA, including significant fines levied for non-market abuse.  See “FSA Fines Former J.C. Flowers Europe CEO for Fraudulent Invoicing Scheme,” The Hedge Fund Law Report, Vol. 5, No. 6 (Feb. 9, 2012).

    Read Full Article …
  • From Vol. 5 No.24 (Jun. 14, 2012)

    Receiver’s Suit to Recover Over $500 Million for Defrauded Investors of Hedge Fund Manager Founding Partners Nears Settlement

    In an unusual arrangement, the receiver for defunct hedge fund manager Founding Partners Capital Management Company is nearing settlement of a $500 million lawsuit against Sun Capital, Inc. and Sun Capital Healthcare, Inc.  This article provides relevant background and details the structure of the potential settlement. 

    Read Full Article …
  • From Vol. 5 No.18 (May 3, 2012)

    SEC Charges Hedge Fund Manager with Fraud as Part of Its Ongoing Regulatory Scrutiny of Secondary Market Trading in Private Pre-IPO Company Shares

    Historically, it has been very difficult for investors to obtain allocations of shares of private companies that are anticipated to conduct an initial public offering of their shares.  To meet this need, a growing secondary market has developed to facilitate secondary market trading in the shares of such private companies, which are often purchased from an issuer’s employees and early investors.  Hedge fund managers have launched funds whose investment strategy is to invest in the shares of these popular private companies.  For the past year, the U.S. Securities and Exchange Commission (SEC) has intensified its scrutiny of this secondary market trading.  As part of that effort, on March 14, 2012, the SEC filed a civil enforcement action against a broker-dealer, an investment adviser and one of their principals who sponsored and managed hedge funds formed to engage in secondary market transactions in the shares of various popular startups, among them, Facebook, Inc., Twitter, Inc. and Zynga Inc.  This article highlights the factual allegations, causes of action and remedies sought by the SEC in its complaint and, in turn, identifies some of the pitfalls that hedge fund managers that employ this trading strategy should avoid.

    Read Full Article …
  • From Vol. 5 No.15 (Apr. 12, 2012)

    Recent New York Court Decision Suggests That Hedge Funds Have a Due Diligence Obligation When Entering into Credit Default Swaps

    Domestic and foreign regulators have historically afforded differing levels of protection to retail investors as opposed to sophisticated investors, such as hedge funds, based on their presumptively differing levels of financial knowledge and abilities to conduct due diligence on prospective investments.  Sophisticated investors have been permitted to invest in more complicated financial products based on their presumed ability to understand and conduct due diligence on such investments.  However, the flip side of enhanced access is diminished investor protection, as evidenced by a recent court decision holding that sophisticated investors have a duty to investigate publicly available information in arms-length transactions.

    Read Full Article …
  • From Vol. 5 No.15 (Apr. 12, 2012)

    Brockton Retirement Board Files Class Action Lawsuit Against Oppenheimer Fund of Private Equity Funds and Executive Officers for Allegedly False Claims Relating to Fund Performance and Investment Valuations Contained in Fund Marketing Materials

    The Jumpstart Our Business Startups Act may portend good news for hedge funds that seek to raise capital from investors.  However, hedge fund managers should approach their investor solicitation efforts with caution, particularly in light of the increasing scrutiny from both regulators and investors with respect to fund performance and valuation.  A recent example of this scrutiny is a class action lawsuit initiated on March 26, 2012 by a Massachusetts retirement fund, Brockton Retirement Board (Brockton), against a private equity fund of funds manager and related entities.  The Complaint generally alleges that the Defendants made false and misleading statements in marketing materials.  This article summarizes the factual allegations in the Complaint, the causes of action and the remedies sought by Brockton.  For a similar story of alleged failure by a fund of funds manager to perform claimed due diligence, see “Federal Court Decision Holds That a Fund of Funds Investor May Sue a Fund of Funds Manager That Fails to Perform Specific Due Diligence Actions Promised in Writing and Orally,” The Hedge Fund Law Report, Vol. 4, No. 27 (Aug. 12, 2011).

    Read Full Article …
  • From Vol. 5 No.14 (Apr. 5, 2012)

    Recent Decision Holds That Hedge Fund Managers Have Some Recourse Against Firm Employees That Engage in Insider Trading and Deceive Their Employers Pursuant to the Mandatory Victims Restitution Act

    Hedge fund managers compensate their employees for services rendered with the expectation that such services will be rendered with competence, integrity and honesty.  However, when employees fail to live up to these expectations, do hedge fund managers have any recourse?  For example, may managers claw back compensation paid to such employees and recoup costs incurred in investigating and defending against securities fraud claims?  A recent decision by the U.S. District Court for the Southern District of New York suggests that, yes, hedge fund managers may in fact have some recourse against rogue employees.

    Read Full Article …
  • From Vol. 5 No.13 (Mar. 29, 2012)

    How Can Offshore Hedge Funds Ensure That Section 10(b) Will Apply to Their Transactions in Securities Not Listed on U.S. Exchanges?

    The recent decision by the United States Court of Appeals for the Second Circuit in Absolute Activist Value Master Fund Limited v. Ficeto has clarified the criteria for application of §10(b) of the Securities Exchange Act of 1934 to transnational transactions involving securities not listed on U.S. domestic exchanges.  See “Second Circuit Clarifies When Offshore Hedge Funds Can Make Section 10(b) Securities Fraud Claims in Connection with ‘Domestic Transactions’ with Conduct and Effects in the United States,” The Hedge Fund Law Report, Vol. 5, No. 11 (Mar. 16, 2012).  Although in Absolute Activist the Second Circuit did not discuss what facts in any particular case would be sufficient to satisfy their subject matter jurisdiction test for application of Rule 10b-5, this ruling has practical implications for offshore hedge funds (and other non-U.S. purchasers) who acquire privately placed securities directly from U.S. issuers or on the secondary market.  In a guest article, Bradley Kulman and Bruce Schneider, both Partners at Stroock & Stroock & Lavan LLP, discuss the factual background and legal analysis in the case as well as some of the practical implications stemming from the decision for offshore hedge funds.

    Read Full Article …
  • From Vol. 5 No.13 (Mar. 29, 2012)

    SEC Enforcement Action Against Investment Adviser Highlights Importance of Conducting Due Diligence on a Hedge Fund’s Auditor to Avoid Fraud

    Although hedge fund investment decisions are based on numerous factors, information relating to a hedge fund’s financial condition and performance results remains a critical component of any such decision.  See “Legal and Operational Due Diligence Best Practices for Hedge Fund Investors,” The Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  Various parties have a hand in creating and confirming the information that goes into financial statements and performance reporting.  Those parties include the manager, the administrator and the auditor.  Many investors pay particularly close attention to reports from auditors because of the rigorous standards governing the accounting profession and the presumably uniform application of those standards across different contexts.  However, information about a hedge fund provided by an accountant is only as good as the accountant itself.  A good accountant can provide, directly or indirectly, good information to an investor – even though the accountant’s duty typically does not flow to the investor – while a bad accountant can provide a false sense of security or, worse, cover for a fraud.  Indeed, a recurring feature of frauds in the hedge fund industry is an accountant that does not exist, is much smaller or less experienced than claimed or that is affiliated with the manager.  An accounting firm that was both fictitious and affiliated with the manager was a notable feature of the Bayou fraud.  See “Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011).  A fraudulent auditor and fictitious financial statements also featured prominently in a recently filed SEC action against an investment adviser.  This article summarizes the SEC’s Complaint in that action and describes five techniques that hedge fund investors can use to confirm the existence, competence and reliability of hedge fund auditors.

    Read Full Article …
  • From Vol. 5 No.11 (Mar. 16, 2012)

    Second Circuit Clarifies When Offshore Hedge Funds Can Make Section 10(b) Securities Fraud Claims in Connection with “Domestic Transactions” with Conduct and Effects in the United States

    Offshore hedge funds should no longer assume that the federal securities laws will universally provide them with protection with respect to their securities transactions that have conduct and effects in the United States.  Recent caselaw makes clear that offshore hedge funds do not have unfettered rights to state claims for relief under Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) with respect to all such transactions.  Thus, an offshore hedge fund’s failure to understand the scope of protection afforded pursuant to Section 10(b) can lead to legal risk if securities fraud should occur, particularly as it relates to domestic transactions in securities other than those listed on domestic exchanges.  A recent Second Circuit opinion clarifies the scope of transactions that will constitute “domestic transactions” in such unlisted securities.  This article summarizes the facts of the case and the Court’s reasoning in its opinion.

    Read Full Article …
  • From Vol. 5 No.9 (Mar. 1, 2012)

    Recent Federal Court Decision Outlines Approach to Determining When a Payment Received by a Service Provider Will Constitute a Fraudulent Transfer from Those Orchestrating a Ponzi Scheme

    The Madoff scandal has demonstrated that receivers appointed on behalf of troubled funds that were actually or allegedly run as Ponzi schemes can aggressively pursue legal action to recover funds misappropriated from investors.  See “Two Recent Federal Court Decisions Clarify the Differing Treatment under SIPA of Returned Principal and Fictitious Profits,” The Hedge Fund Law Report, Vol. 4, No. 34 (Sep. 29, 2011).  To date, receivers continue to aggressively pursue such actions.  This article outlines the approach recently taken by a federal court in determining when a fraudulent transfer has been made to a service provider from persons that have operated a Ponzi scheme.

    Read Full Article …
  • From Vol. 5 No.6 (Feb. 9, 2012)

    Massachusetts Superior Court Dismisses Investors’ Claims Against Hedge Fund Manager Dutchess Capital, its Auditor, Administrator, Principals and Affiliate

    Plaintiffs in this action were investors in two hedge funds managed by Dutchess Capital Management, LLC (Dutchess Capital).  When those investments failed, plaintiffs commenced suit against Dutchess Capital, an affiliate, its principals, its outside auditor and its administrator.  They alleged breach of contract, breach of fiduciary duty, malpractice, fraud and similar claims.  The Court granted defendants’ motion to dismiss, holding that plaintiffs lacked standing to bring certain derivative claims, that the Court lacked jurisdiction over the fund administrator and that the remaining claims were barred by the applicable statutes of limitations.  This article summarizes the Court’s decision.

    Read Full Article …
  • From Vol. 5 No.6 (Feb. 9, 2012)

    FSA Fines Former J.C. Flowers Europe CEO for Fraudulent Invoicing Scheme

    On January 31, 2012, the UK Financial Services Authority (FSA) issued a Final Notice announcing that it fined Ravi Shankar Sinha, former UK Chief Executive Officer (CEO) of private equity fund manager J.C. Flowers.  The fine, UK £2.87 million (US $4.52 million), represents one of the largest penalties ever imposed by the FSA on an individual in a non-market abuse case.  The Final Notice also banned Sinha from working in financial services in the UK.  Notably, this fine is the latest in a series of recent and vigorous enforcement actions by the FSA against private fund managers.  It comes only a week after the FSA imposed a £7.2 million (US $11 million) fine on David Einhorn and his hedge fund management company, Greenlight Capital, for allegedly using confidential information to trade in the stock of a British pub chain.  See “FSA Imposes £7.2 Million Penalty on Hedge Fund Manager David Einhorn and Greenlight Capital for Unintentional Insider Dealing in Shares of British Pub Owner Punch Taverns Plc,” The Hedge Fund Law Report, Vol. 5, No. 5 (Feb. 2, 2012).  This article summarizes: the structure of the various J.C. Flowers entities (as described in the FSA’s Final Notice); the Final Notice with regard to Sinha; the rationale for the FSA’s actions; and the criteria used by the FSA in assessing financial penalties or imposing prohibition orders against private fund industry participants.

    Read Full Article …
  • From Vol. 4 No.44 (Dec. 8, 2011)

    SEC Accuses Former Portfolio Manager of Hedge Fund Millennium Global Emerging Credit Fund and Broker-Dealer Accomplice of Fraud in Conspiring to Inflate the Fund’s NAV

    In parallel civil and criminal actions, the SEC and DOJ, respectively, brought charges alleging hedge fund valuation fraud.  Like the LeadDog matter described above, the SEC action was brought as part of the Enforcement Division’s Aberrational Performance Inquiry.  This article describes the factual and legal allegations, and sheds additional light on what the Aberrational Performance Inquiry means for hedge fund managers.

    Read Full Article …
  • From Vol. 4 No.41 (Nov. 17, 2011)

    SEC Commences Fraud Action against a Purported Hedge Fund Manager for Providing False Background Information and Including False Information on a Website

    On October 26, 2011, the Securities and Exchange Commission (SEC) filed suit against Andrey Hicks and the hedge fund manager he ran, Locust Offshore Management, LLC (LOM), alleging that they defrauded investors by fabricating the existence of a British Virgin Islands-incorporated pooled investment fund.  The SEC’s complaint (Complaint) also names the purported fund, Locust Offshore Fund, Ltd. (LOF), as a relief defendant.  The Complaint, among other things, sheds new light on an old due diligence verity – the imperative of thorough background checks.  See “In Conducting Background Checks of Hedge Fund Managers, What Specific Categories of Information Should Investors Check, and How Frequently Should Checks be Performed?,” The Hedge Fund Law Report, Vol. 2, No. 36 (Sep. 9, 2009).

    Read Full Article …
  • From Vol. 4 No.39 (Nov. 3, 2011)

    Fund of Hedge Funds Aris Multi-Strategy Fund Wins Arbitration Award against Underlying Manager Based on Allegations of Self-Dealing

    According to press reports, on September 28, 2011, Javier Guerra, the portfolio manager of Quantek Asset Management, LLC (QAM) and Quantek Opportunity Fund, LP (Partnership or Feeder Fund), resigned from the Partnership’s Board of Directors as a result of a loss in arbitration to fund of hedge funds investor Aris Multi-Strategy Fund (Aris).  The arbitration panel reportedly concluded that QAM fraudulently induced Aris to invest in the Feeder Fund and ordered Guerra to pay $1 million in damages; Aris had invested $15 million in the Feeder Fund.  This article details the relevant factual and legal allegations in publicly available court documents, and includes links to those documents.  For more on litigation involving Aris, see “New York State Supreme Court Dismisses Hedge Funds of Funds’ Complaint against Accipiter Hedge Funds Based on Exculpatory Language in Accipiter Fund Documents and Absence of Fiduciary Duty ‘Among Constituent Limited Partners,’” The Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17, 2010); “New York Supreme Court Rules that Aris Multi-Strategy Funds’ Suit against Hedge Funds for Fraud May Proceed, but Negligence Claims are Preempted under Martin Act,” The Hedge Fund Law Report, Vol. 2, No. 51 (Dec. 23, 2009).  For more on the views of Aris’ principals with respect to litigation by hedge fund investors against hedge fund managers, see “Why Are Most Hedge Fund Investors Reluctant to Sue Hedge Fund Managers, and What Are the Goals of Investors that Do Sue Managers?,” The Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009).

    Read Full Article …
  • From Vol. 4 No.36 (Oct. 13, 2011)

    SEC Accuses Corey Ribotsky and Hedge Fund Manager NIR Group, LLC of Misappropriating Assets and Misleading Investors in Connection with PIPEs

    On September 28, 2011, the SEC filed a civil complaint in the United States District Court for the Southern District of New York against an unregistered hedge fund management firm, The NIR Group, LLC (NIR), its sole managing member, Corey Ribotsky, and an NIR analyst, Daryl Dworkin (together, defendants).  This article details the allegations in the SEC’s complaint and briefly outlines NIR’s press release in response.  See also “New York Appellate Division Dismisses Investors’ Complaint Against Corey Ribotsky and Hedge Fund AJW Qualified Partners, Holding that Fund’s Decision to Suspend Redemptions Did Not Constitute a Breach of the Fund’s Operating Agreement or a Breach of Fiduciary Duty,” The Hedge Fund Law Report, Vol. 4, No. 16 (May 13, 2011); “Investors Sue Hedge Fund Managed By N.I.R. Group and Corey Ribotsky in Redemption Dispute,” The Hedge Fund Law Report, Vol. 2, No. 32 (Aug. 12, 2009).

    Read Full Article …
  • From Vol. 4 No.33 (Sep. 22, 2011)

    An Investment Adviser May Not Call Itself Independent If It Receives Fees from Underlying Managers

    The SEC recently commenced administrative proceedings against an investment adviser that allegedly received undisclosed fees for channeling over $80 million into SJK Investment Management, LLC (SJK).  As previously reported in The Hedge Fund Law Report, on January 6, 2011, the SEC filed an emergency civil injunctive action charging SJK and its principal, Stanley Kowalewski, with securities fraud, and obtained a temporary restraining order and asset freeze against SJK and Kowalewski.  See “Thirteen Important Due Diligence Lessons for Hedge Fund Investors Arising Out of the SEC’s Recent Action against a Fund of Funds Manager Alleging Misuse of Fund Assets,” The Hedge Fund Law Report, Vol. 4, No. 3 (Jan. 21, 2011).  The order in this administrative proceeding (Order) is interesting to hedge fund and hedge fund of funds managers primarily in helping clarify the circumstances in which managers may and may not claim to be “independent.”  The facts alleged by the SEC are rather egregious, and thus the Order itself does not make noteworthy new law.  However, the Order does raise close and interesting questions regarding the language of representations that hedge fund of fund managers and other investment advisers may make to investors with respect to independence; the channels through which such representations are made (including websites); how to approach disclosure with respect to conflicts and independence in Form ADV; and how to move client assets from one investment manager to another without breaching fiduciary duties or running afoul of the antifraud provisions of the federal securities laws.

    Read Full Article …
  • From Vol. 4 No.31 (Sep. 8, 2011)

    Second Circuit Upholds $60 Million Restitution Order against Matthew Marino for Serving as an Employee of the Fictitious Accounting Firm That Helped Facilitate the Bayou Hedge Fund Fraud

    On August 18, 2011, the United States Court of Appeals for the Second Circuit upheld a district court’s $60 million restitution order imposed on Matthew Marino (defendant) to repay the victims of the Bayou hedge fund group Ponzi scheme orchestrated by his brother Daniel Marino, Samuel Israel III and James Marquez.  As previously reported in The Hedge Fund Law Report, Daniel Marino, Israel and Marquez engaged in a Ponzi scheme using the Bayou group of hedge funds, which cost investors – according to numbers in the Second Circuit’s decision – upwards of $500 million.  For a discussion of the mechanics of the Ponzi scheme, as well as a detailed analysis of relevant litigation, see “Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011).  The likelihood of collecting $60 million from Marino is probably as fanciful as the “independent auditor” that purportedly employed him.  Nonetheless, the decision evidences the willingness of an important appellate court to cast a wide net of liability and restitution in connection with a hedge fund Ponzi scheme.  Accordingly, the decision may bear on – among other legal and investment matters – the value of claims in connection with other or future frauds.  See “Two Key Levels of Risk Facing Hedge Funds That Buy or Sell Bankruptcy Claims,” The Hedge Fund Law Report, Vol. 4, No. 27 (Aug. 12, 2011).  This article details the relevant factual background and the Court’s legal analysis.

    Read Full Article …
  • From Vol. 4 No.27 (Aug. 12, 2011)

    Federal Court Decision Holds That a Fund of Funds Investor May Sue a Fund of Funds Manager That Fails to Perform Specific Due Diligence Actions Promised in Writing and Orally

    A recent federal district court order (Order) described the range of legal claims available to an investor in a hedge fund of funds for alleged inconsistencies between the fund of funds manager’s representations and actions regarding due diligence and monitoring.  Read narrowly, the Order may merely stand for the proposition that a fund of funds manager may not promise to undertake specific actions in the course of due diligence and monitoring, accept investor money based on those representations then fail to take those actions.  Read more broadly, the Order may foreshadow a heightening of the legal standard to which hedge fund of funds managers are held when conducting due diligence and monitoring.  That is, the Order may presage a decision on the merits to the effect that fund of funds managers have a legal duty more or less consonant with industry best practices regarding due diligence.  That would constitute a significant increase in the level of legal obligations applicable to fund of funds managers, but would not enhance the commercial standard of care, which already demands best practices.

    Read Full Article …
  • From Vol. 4 No.26 (Aug. 4, 2011)

    SEC Order against Pegasus Investment Management Suggests That a Hedge Fund Manager Cannot Keep the Proceeds of an Undisclosed “Rental” of Its Trading Volume

    A recent SEC order instituting administrative and cease-and-desist proceedings against a small hedge fund manager confirms the principle that hedge fund investors – not managers – own the assets in funds and any assets generated with those assets, subject to specific exceptions.  The matter also addresses, albeit indirectly and inconclusively, the question of whether hedge funds may agree by contract to permit conduct by the manager that, absent such agreement, would constitute fraud or a breach of fiduciary duty.

    Read Full Article …
  • From Vol. 4 No.25 (Jul. 27, 2011)

    Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices

    The United States District Court for the Southern District of New York recently issued judgments in favor of three bankrupt hedge funds in fraudulent conveyance actions against investors that redeemed within two years of the funds’ bankruptcy filings.  The hedge funds were members of the Bayou group of hedge funds, which – as the hedge fund industry knows well – was a fraud that collapsed in August 2005, resulting in bankruptcy filings by the Bayou funds and related entities in May 2006.  These judgments are very important for hedge fund investors because they illustrate what appears to be a direct conflict between bankruptcy law and hedge fund due diligence best practices.  In short, hedge fund due diligence best practices currently counsel in favor of redemption at the first whiff of fraud on the part of a manager.  However, bankruptcy law appears to require a hedge fund investor to undertake a “diligent investigation” when it obtains facts that put it on inquiry notice of insolvency of the fund or a fraudulent purpose on the part of the manager.  The immediacy of a prompt redemption is directly at odds with the delay inherent in a diligent investigation.  How can hedge fund investors reconcile the practical goal of prompt self-help with the legal obligation of a diligent investigation?  To help answer that question, this feature length article surveys the factual and procedural history of the Bayou matters, then analyzes the arguments and outcome in the recent Bayou trial.  The primary question at the trial was whether certain investors that redeemed from the Bayou funds could keep their redemption proceeds based on “good faith” defenses to the Bayou estate’s fraudulent conveyance actions.  In the absence of a court opinion, The Hedge Fund Law Report analyzed the 142-page transcript of the closing arguments, as well as the motion papers filed by the parties and four prior bankruptcy court and district court opinions.  This article embodies the results of our analysis.  The article concludes by identifying five ways in which hedge fund investors may reconcile hedge fund due diligence best practices with the seemingly draconian outcome in these recent Bayou judgments.

    Read Full Article …
  • From Vol. 4 No.25 (Jul. 27, 2011)

    Fourteen Due Diligence Lessons to Be Derived from the SEC’s Recent Action against a Serial Practitioner of Hedge Fund Fraud

    On July 13, 2011, the SEC issued an Order making findings and imposing remedial sanctions against an individual hedge fund manager.  The Order describes a career involving modest and infrequent investment successes, and predominantly characterized by repeated, serial and egregious frauds.  The diversity and audacity of the frauds make for lurid reading, but the relevance of the Order for The Hedge Fund Law Report and our subscribers resides in the due diligence lessons to be derived from the factual findings.  This article details the factual findings in the Order, then extracts 14 distinct due diligence lessons from those facts.  Many of our institutional investor subscribers will read the factual findings and say, “This could never happen to me.”  And they may be right.  But we never cease to be amazed by the level of sophistication of investors caught up in even the most crude and simple frauds.  Perhaps this is because our industry is based on trust, and despite the salience of fraud, fraud remains (fortunately) the exception to the wider rule of ethical conduct.  Perhaps it is because frauds that look simple in retrospect were difficult to discover in the moment.  Regardless of the reason, hedge fund investors of all stripes and sizes can benefit from ongoing refinement of their due diligence practices.  And we continue to believe that the best way to refine due diligence practices is to look at what went wrong in actual cases and to revise your list of questions and techniques accordingly.  Here is a useful test for hedge fund investors: read the facts of this matter, as described in this article, then pause to ask yourself: Would our current due diligence practices have discovered all of these facts and caused us to pass on this investment or to redeem?  If the answer is yes, you can stop reading.  But if the answer is no – that is, if your due diligence practices may have missed any aspect of this fraud – we strongly encourage you to read and incorporate our fourteen lessons.  We would also note that we have undertaken similar exercises with respect to prior SEC actions.  That is, we have reviewed allegations of hedge fund manager fraud and detailed the due diligence steps that may have uncovered such frauds.  All of our thinking on this topic is available in the “Due Diligence” section of our Archive.

    Read Full Article …
  • From Vol. 4 No.25 (Jul. 27, 2011)

    District Court Holds that a Hedge Fund Manager Cannot Reasonably Rely on a Single Statement by the Potential Acquirer of a Corporate Division that an Acquisition Was “99.9% Done”

    In December 2007, Chinatron Group Holdings, Limited (Chinatron), a distributor of mobile phones, approached plaintiff Sofaer Global Hedge Fund (Fund) for a $10 million loan.  Chinatron’s principal, John Maclean-Arnott (Arnott), claimed that Chinatron had a firm deal to sell one of its subsidiaries to defendant Brightpoint, Inc. (Brightpoint) and that the proceeds of sale would be used to repay the Fund’s loan.  The Fund claimed that, during a December 17, 2007 conference call among Arnott, Michael Sofaer and defendant Robert Laikin (Laikin), Brightpoint’s founder, Laikin told Sofaer that Brightpoint intended to buy one of Chinatron’s subsidiaries for $14 million within a few months and that the deal was “99.9% done.”  Based on those representations, the Fund lent Chinatron $10 million, which was to be repaid in three months with a $2 million “premium” and other upside potential.  Brightpoint’s acquisition, however, never proceeded and Chinatron defaulted on the Fund’s loan.  The Fund sued Brightpoint and Laikin for fraud.  The defendants moved for summary judgment.  In a scathing and entertaining decision, the District Court assessed the merits of the Fund’s complaint.  We summarize that decision.

    Read Full Article …
  • From Vol. 4 No.23 (Jul. 8, 2011)

    Federal District Court Opinions Address the Mechanics of Repatriating Offshore Hedge Fund Assets Connected to a Fraud and When Private Parties May Intervene in an SEC Action against a Hedge Fund Manager

    On June 28, 2011, the United States Securities and Exchange Commission (SEC) announced that Highview Point Partners LLC (Highview) and its affiliated hedge funds had abided by a court order and returned $230 million from an offshore account to the United States.  The announcement followed in the wake of the SEC civil enforcement action in the U.S. District Court for the District of Connecticut (District Court) against Francisco Illarramendi, his unregistered investment advisory firm, Michael Kenwood Capital Management LLC (MK Capital), and Highview, an affiliated registered advisory firm.  See “Eight Important Due Diligence Lessons for Hedge Fund Investors Arising Out of the SEC’s Recent Action against a Hedge Fund Manager Alleging Misuse of Hedge Fund Assets to Make Personal Private Equity Investments,” The Hedge Fund Law Report, Vol. 4, No. 4 (Feb. 3, 2011).  The ongoing action, in which the SEC has accused these entities of misappropriating investor assets and engaging in a Ponzi scheme, had named their affiliated hedge funds as relief defendants and had sought to freeze their assets and repatriate assets from overseas.  Investors in these affiliated hedge funds had also sought to intervene as of right or permissively in the SEC’s action to protect their financial interests.  In two opinions issued on June 16, 2011, the District Court addressed the investors’ request for intervention and the SEC motion to repatriate funds.  This article details the background of the litigation and the court’s legal analysis of the repatriation and intervention issues.

    Read Full Article …
  • From Vol. 4 No.21 (Jun. 23, 2011)

    SEC’s Fraud Suit Against Principals of Palisades Master Fund for Overvaluation of “Side Pocket,” Misappropriation of Assets and Improper Short-Selling Survives Motion to Dismiss

    In October 2010, the Securities and Exchange Commission (SEC) brought civil securities fraud charges against defendants Paul T. Mannion, Jr., and Andrew S. Reckles, and the investment advisers they controlled, claiming that they defrauded investors in hedge fund Palisades Master Fund, L.P. (Fund) by lying to investors about the value of the Fund’s stake in World Health Alternatives, Inc. (WHA), stealing and exercising WHA warrants owned by the Fund, failing to disclose their private sales of WHA stock and concealing a short position in Radyne Corporation at the time that the Fund invested in that corporation’s PIPE offering.  For a detailed summary of the SEC’s complaint, see “SEC Brings Civil Securities Fraud Action Against Principals of Hedge Fund Palisades Master Fund, Alleging Fraud, Self-Dealing, Misuse of Fund Assets and Use of a ‘Side Pocket’ to Misrepresent the Fund’s Value to its Investors,” The Hedge Fund Law Report, Vol. 3, No. 42 (Oct. 29, 2010).  The Defendants moved to dismiss the entire complaint on the ground that it failed to state any cause of action against the Defendants.  The District Court generally permitted all counts of the complaint to proceed.  We summarize the factual background and the Court’s legal analysis.

    Read Full Article …
  • From Vol. 4 No.19 (Jun. 8, 2011)

    How Can Hedge Fund Managers Avoid Criminal Securities Fraud Charges When Allocating Trades Among Multiple Funds and Accounts?

    All hedge fund managers that manage multiple funds and accounts – which is to say, the vast majority of hedge fund managers – have to draft, implement and enforce policies and procedures governing the allocation of trades among those funds and accounts.  Where those funds and accounts follow explicitly different strategies, the appropriate approach to allocations is relatively straightforward.  For example, if a manager manages an equity long/short fund and a credit fund, equities go to the equity fund and bonds go to the credit fund.  But where multiple funds and accounts may be eligible to invest in the same security, the appropriate approach to allocations is more challenging.  For example, if a manager manages an equity long/short fund and an activist fund and purchases a block of public equity, how and when should the manager determine how to allocate the block between the two funds?  While the specifics of an allocations policy will depend on the manager’s fund structures and strategies, some general principles and proscriptions apply.  As for principles, an allocations policy should be equitable, should take into account the size and strategies of various funds, should provide a mechanism for correcting allocation errors and should give the manager an appropriate degree of discretion in making allocation determinations.  As for proscriptions, the boundaries of “appropriate discretion” in this context generally are set by the anti-fraud provisions of the federal securities laws and principles of fiduciary duty.  In other words, you cannot allocate trades in a manner that constitutes securities fraud.  How might trade allocations constitute securities fraud?  A recent SEC order (Order) answers that question; and a prior criminal indictment (Indictment, and together with the Order, the Charging Documents) and plea arising out of the same facts raises the frightening prospect that in more egregious circumstances, fraudulent trade allocation practices may constitute criminal securities fraud.  This article explains the facts and legal violations that led to the Order, Indictment and plea, then discusses the implications of this matter for hedge fund managers in the areas of trade allocations, marketing, disclosure on Form ADV and creation and maintenance of books and records.  In particular, this article discusses: why the cherry-picking scheme at issue in this matter was not just a bad legal decision, but also a bad business decision; two types of cherry-picking; whether and in what circumstances cherry-picking may lead to criminal liability; how the sometimes purposeful vagary of criminal indictments can subtly expand the reach of white collar criminal liability; whether disclosure can cure trade allocation practices that are otherwise fraudulent; the compliance utility of technology; conflicts of interest inherent in one person serving as chief compliance officer and in other roles; whether post-trade allocations are ever permissible; how hedge fund managers can test the sufficiency of their trade allocation policies; how trade allocation policies interact with the transparency rights sometimes granted to larger hedge fund investors; and the idea of “cross-fund transparency.”

    Read Full Article …
  • From Vol. 4 No.19 (Jun. 8, 2011)

    The Supreme Court Rejects Loss Causation Requirement at Class Certification Stage

    On June 6, 2011, in Erica P. John Fund, Inc. v. Halliburton Co., the Supreme Court unanimously held that private securities fraud plaintiffs do not need to prove loss causation in order to obtain class certification.  The high court drew a firm line between two separate elements of a private securities fraud claim: (1) reliance on alleged misrepresentations or omissions, and (2) loss causation.  In a guest article, Jonathan K. Youngwood and Joseph M. McLaughlin, litigation partners with Simpson Thacher & Bartlett LLP in New York, discuss the factual and procedural background of the decision, the Supreme Court’s legal analysis and the implications of the decision for private securities fraud litigation.

    Read Full Article …
  • From Vol. 4 No.17 (May 20, 2011)

    When Does the SEC Acquire the Right to Freeze the Assets of a Hedge Fund or Appoint a Receiver over a Hedge Fund?

    As previously reported in The Hedge Fund Law Report, on March 24, 2011, the SEC brought a civil enforcement action against Marlon Quan, and the firms he managed, Acorn Capital Group, LLC (ACORN) and Stewardship Investment Advisors, LLC (SIA), in the U.S. District Court for the District of Minnesota.  The SEC accused Quan of using his hedge funds to facilitate a Ponzi scheme orchestrated by Thomas J. Petters by funneling hundreds of millions of dollars of investor money to Petters, while falsely assuring investors of actions taken to protect their investments.  See “SEC’s Hedge Fund Focus to Include Review of Funds That Outperform the Market,” The Hedge Fund Law Report, Vol. 4, No. 14 (Apr. 29, 2011).  The SEC filed the action on that date in order to stop the imminent distribution of approximately $14 million in settlement funds – obtained from the Petters’ bankruptcy and receivership estates – to certain of Quan’s offshore hedge funds, and to prevent Quan from allegedly dispersing more assets to individuals associated with him.  The SEC did so, it said, to protect the interests of investors in Quan’s onshore hedge funds.  Thus, the SEC also named as “relief defendants” (defined as persons or entities who received ill-gotten funds or assets as a result of the illegal acts of the defendants) the company that held the settlement funds on behalf of Quan’s associated entities, Asset Based Resource Group (ABRG), and Florene Quan, Quan’s wife who allegedly received certain properties from Quan for nominal value.  See, by way of background, “Connecticut District Court Dismisses Complaint Against Hedge Fund Manager and Investment Adviser for Lack of Venue,” The Hedge Fund Law Report, Vol. 2, No. 20 (May 20, 2009).  After filing the complaint, the SEC immediately filed a motion to obtain an order freezing the assets of all named defendants, appointing a receiver over certain of Quan’s onshore entities and ABRG, and enjoining Quan, Acorn and SIA from further violations of securities laws.  A Bermuda court-appointed liquidator, who took over Quan’s offshore hedge funds, successfully moved to intervene for the limited purpose of being heard regarding the disbursement of settlement proceeds and to object to the appointment of a receiver over ABRG.  We detail the background of the action and the Court’s legal analysis.  For more on receivers in the hedge fund context, see “Seventh Circuit Approves Federal Receiver’s Hedge Fund Liquidation Plan Subordinating Priority Rights of Redeeming Investors; Agrees That Equity Mandates That All Investors, Redeeming and Not, Be Treated Equally Where Fund Lacks Sufficient Assets to Make Them Whole,” The Hedge Fund Law Report, Vol. 3, No. 50 (Dec. 29, 2010).

    Read Full Article …
  • From Vol. 4 No.15 (May 6, 2011)

    Federal Energy Regulatory Commission Upholds Administrative Law Judge Ruling that Imposes $30 Million Penalty on Former Amaranth Trader Brian Hunter for Natural Gas Market Manipulation During 2006

    Defendant Brian Hunter (Hunter) was an executive and head natural gas trader at hedge fund manager Amaranth Advisors, LLC (Amaranth).  The Federal Energy Regulatory Commission (FERC), which has jurisdiction over interstate sales of natural gas and electricity, has upheld in all respects the findings of a FERC administrative law judge who found Hunter guilty of manipulation of the natural gas market and imposed a $30 million penalty on him.  At the end of February, March and April 2006, Hunter sold large volumes of natural gas futures contracts on their expiration dates in order to drive down the settlement prices of those contracts.  Gas futures contracts trade on the New York Mercantile Exchange (NYMEX).  FERC argued that, unbeknownst to traders on the NYMEX, Hunter had amassed short positions in natural gas swap agreements that referenced the settlement prices of the gas futures contracts.  Consequently, he stood to profit from the drop in the settlement price of gas futures contracts that occurred when Amaranth dumped those contracts on their expiration dates.  Amaranth collapsed in late 2006, in large part because of the bets it had made on the natural gas market.  FERC determined that Hunter’s trading was intended to manipulate the price of natural gas futures contracts, was done knowingly and had an effect on the market for natural gas.  FERC bills this case as the “first fully litigated proceeding involving FERC’s enhanced enforcement authority under section 4A of the Natural Gas Act, which prohibits manipulation in connection with transactions subject to FERC jurisdiction.”  The trading at issue occurred only in the futures market, rather than in the physical gas market.  We summarize FERC’s decision.  See also “Federal District Court Dismisses Lawsuit Brought by San Diego County Employees Retirement Association against Hedge Fund Manager Amaranth Advisors and Related Parties for Securities Fraud, Gross Negligence and Breach of Fiduciary Duty,” The Hedge Fund Law Report, Vol. 3, No. 12 (Mar. 25, 2010).

    Read Full Article …
  • From Vol. 4 No.9 (Mar. 11, 2011)

    First Department Decision May Give Aggrieved Hedge Fund Investors an Unexpected and Powerful Avenue of Redress

    The Martin Act (New York General Business Law §§ 352-359) prohibits various fraudulent and deceitful practices in the distribution, exchange, sale and purchase of securities.  It authorizes the New York Attorney General to investigate these activities and seek relief against sellers of securities engaged in dishonest or deceptive activities.  For more on the Martin Act in the hedge fund context, see “New York Supreme Court Rules that Aris Multi-Strategy Funds’ Suit against Hedge Funds for Fraud May Proceed, but Negligence Claims are Preempted under Martin Act,” The Hedge Fund Law Report, Vol. 2, No. 51 (Dec. 23, 2009); “Federal Court Dismisses Breach of Fiduciary Duty Claim, but Permits Securities Fraud Claim, Against Alternative Investment Fund and Its Manager and Principals,” The Hedge Fund Law Report, Vol. 2, No. 3 (Jan. 21, 2009).  The Martin Act does not create a private right of action for such violations, however.  See CPC Int’l v. McKesson Corp., 70 N.Y.2d 268 (1987).  Enterprising defendants have used that proposition to argue not only that no private right of action exists, but also that the Martin Act preempts certain private common law claims arising from the conduct covered by the statute.  To date, New York State and a majority of federal courts have found this argument persuasive, and applied it to non-fraud-based common law claims, such as breach of fiduciary duty and negligent misrepresentation.  Hence, many defendants have succeeded in having these claims dismissed.  This has been especially true in the federal courts’ construction of New York law.  However, a recent and notable decision of the Appellate Division, First Department repudiates this trend.

    Read Full Article …
  • From Vol. 4 No.3 (Jan. 21, 2011)

    Thirteen Important Due Diligence Lessons for Hedge Fund Investors Arising Out of the SEC’s Recent Action against a Fund of Funds Manager Alleging Misuse of Fund Assets

    The SEC recently obtained an emergency asset freeze and temporary restraining order against a hedge fund of funds manager, Stanley J. Kowalewski (Kowalewski), and his management entity, SJK Investment Management LLC (SJK).  The SEC’s complaint, filed in federal district court in Atlanta, generally alleges that Kowalewski and SJK engaged in two categories of conduct in violation of federal securities laws.  First, Kowalewski and SJK allegedly used fund assets to pay management company and personal expenses.  Second, Kowalewski allegedly launched a hedge fund in which his fund of funds invested, but failed to disclose to his fund of funds investors either the existence of the underlying hedge fund or the investment by his fund of funds in it.  Neither the dollar values nor the creativity in this matter are particularly noteworthy.  The alleged fraud itself was trite, brief and straightforward.  However, a close reading of the SEC’s complaint offers a veritable treasure trove of insight into how investors in hedge funds and funds of funds can sharpen their due diligence practices.  We have extracted 13 key lessons from the matter that investors can use to revise their approach to hedge fund due diligence – or, even better, to confirm that their approach reflects current best practices.  This article details the SEC’s factual and legal allegations against Kowalewski and SJK, briefly discusses the procedural posture of the matter, then discusses in detail the 13 key lessons.

    Read Full Article …
  • From Vol. 4 No.3 (Jan. 21, 2011)

    Federal Court Decision Provides Guidance to Newly Registered Hedge Fund Managers on Litigation Strategy in Enforcement Actions Brought by the SEC

    On December 2, 2010, Magistrate Judge Sheila Finnegan of the U.S. District Court for the Northern District of Illinois issued an order partially granting a discovery motion filed by Eric A. Bloom, the former President and CEO of Sentinel Management Group, Inc., a registered investment adviser, in a civil enforcement action brought by the U.S. Securities and Exchange Commission (SEC) against Sentinel, Bloom and Sentinel Senior Vice President Charles K. Mosley.  The SEC had accused Bloom and Mosley of engaging in a massive fraud from around October 2002 through August 2007 relating to their use of client assets.  In response, Bloom sought the SEC’s file for Sentinel from an examination it conducted in January and February 2002, in the hope that it may contain relevant information, and sought answers to his interrogatories relating to any witness interviews the SEC conducted with Sentinel staff in preparation for litigation.  Although Sentinel was a registered investment adviser that managed cash for hedge funds, rather than being a hedge fund manager itself, this decision is nonetheless relevant to hedge fund managers, especially as more hedge fund managers become subject to a registration requirement, SEC examinations and resulting enforcement actions.  Specifically, the decision sheds light on the merits of a litigation strategy adopted by a hedge fund industry participant and its principals in litigation against the SEC.  Thus, the decision offers lessons regarding when to litigate or settle, how to craft a litigation strategy, and which documents may be obtained via discovery requests.  We detail the background of the action and the court’s pertinent legal analysis.

    Read Full Article …
  • From Vol. 4 No.1 (Jan. 7, 2011)

    U.S. District Court Dismisses Hedge Funds’ Fraud Suit Against Porsche, Holding that Anti-Fraud Provisions of U.S. Securities Laws Do Not Apply to Swap Agreements that Reference Foreign-Traded Volkswagen Stock, Even If Those Agreements Were Made In the U.S. and Governed By U.S. Law

    Plaintiffs in this consolidated action are a number of domestic and offshore hedge funds that had taken significant short positions in the stock of Volkswagen AG (VW) during 2008.  Unbeknownst to those hedge funds, defendant Porsche Automobil Holding SE (Porsche) had quietly amassed, outright or through undisclosed options, the right to purchase over 75% of VW’s stock.  Porsche had never disclosed its intention to acquire such a large percentage of VW stock.  When Porsche eventually announced the true extent of its VW holdings, the plaintiff hedge funds were caught in a massive short squeeze and reportedly lost over $2 billion covering their short positions.  Both Porsche and VW are German corporations.  Although both corporations have ADRs available on U.S. exchanges, the funds achieved their short positions through securities-based swap agreements that referenced VW stock.  The funds sued Porsche and two of its executives in U.S. District Court for the Southern District of New York, claiming violations of the antifraud provisions of the Securities Exchange Act of 1934 and common law fraud.  Porsche and the individual defendants moved to dismiss the complaint for failure to state a claim upon which relief could be granted, arguing that U.S. securities laws did not apply to the swap transactions in question.  Relying on the U.S. Supreme Court’s recent decision in Morrison v. National Australia Bank, 130 S. Ct. 2869 (2010), the District Court dismissed all federal fraud claims, holding that the U.S. securities laws were not intended to apply to transactions in foreign securities, even if one of the parties is based in the United States.  We summarize the Court’s decision.  For further discussion of the ability of U.S.-based hedge funds to sue foreign corporations in U.S. courts for violations of the antifraud provisions of the U.S. securities laws, see “Are There Avenues for Recovery in United States Courts for Overseas Hedge Fund Losses?,” The Hedge Fund Law Report, Vol. 2, No. 29 (Jul. 23, 2009); “Update: Are There Still Avenues for Recovery in United States Courts for Overseas Hedge Fund Losses After Morrison v. National Australia Bank Ltd.?,” The Hedge Fund Law Report, Vol. 3, No. 27 (Jul. 8, 2010).

    Read Full Article …
  • From Vol. 3 No.50 (Dec. 29, 2010)

    Ten Due Diligence Questions that Might Have Helped Uncover the Fraud Described in the SEC's Recent Administrative Proceeding against Subprime Automobile Loan Hedge Fund Manager and Its Principals

    On December 21, 2010, the SEC instituted and settled administrative proceedings against a San Francisco-based hedge fund management company and its principals.  A hedge fund managed by that company purported to invest almost exclusively in subprime auto loans, but in fact wound up "investing" largely in debt owed to the fund by entities controlled by principals of the management company and other hedge funds managed by the management company.  The SEC's Order in the matter is a study in conflicts of interest, strategy drift, material misstatements and omissions in offering documents and Form ADV and improper principal trades.  Working from the alleged facts of this matter, we derive ten due diligence questions that any investor should add to its questionnaire or incorporate into in-person meetings with managers.  Importantly, these are questions that should be asked periodically, not just prior to an initial investment.

    Read Full Article …
  • From Vol. 3 No.49 (Dec. 17, 2010)

    Settlement of SEC Fraud Charges by Small San Francisco-Based Hedge Fund Manager Highlights Importance of Valuation Checks and Balances

    On December 1, 2010, the SEC instituted and simultaneously settled fraud charges against an individual hedge fund manager based in San Francisco.  (This matter is further evidence of reinvigorated enforcement efforts by the SEC's San Francisco office.  For a discussion of another matter recently initiated by that office, see "SEC Commences Civil Insider Trading Action Against Deloitte Mergers and Acquisitions Partner and Spouse Who Allegedly Tipped Off Relatives to Impending Acquisitions of Seven Public Companies," The Hedge Fund Law Report, Vol. 3, No. 48 (Dec. 10, 2010).)  The allegations in the SEC's Order tell a familiar story: a young manager raises, at peak, $30 million; while the Order does not specify, the money likely came from friends and family.  The manager experiences losses in a relatively conservative investment strategy.  The manager, presumably embarrassed, tells his investors that everything is fine, while trying to make up those losses by taking on slightly more risk.  But instead, the manager loses more money, and his misrepresentations to investors depart to a greater extent from the facts.  Eventually, the manager comes clean, the fund is liquidated and the manager is charged by the SEC with civil fraud.  What is noteworthy about this matter are two statements in the SEC's order.

    Read Full Article …
  • From Vol. 3 No.36 (Sep. 17, 2010)

    In Continuing Saga of Collapse of Hedge Fund Parkcentral Global, Brown Investment Management Sues Fund’s Auditor, Ernst & Young, Claiming Fraud, Negligence and Breach of Fiduciary Duty

    In late 2008, plaintiff Brown Investment Management, L.P. (Brown) and other investors purchased an aggregate $17 million of limited partnership interests in hedge fund Parkcentral Global, L.P. and Parkcentral Global Fund Limited, both of which fed all their invested assets into Parkcentral Global Hub Limited (Fund).  Despite the Fund’s numerous representations that it would not commit more than 5% of its assets to any one of its investment strategies, or lose more than 5% of net asset value in a worst case scenario, the Fund collapsed in 2008 after making a huge unhedged bet on mortgage backed securities.  The investors’ entire $17 million was wiped out within months.  A 2009 class action is pending against various Fund employees and certain entities allegedly controlled by Ross Perot and his family.  Based in part on the allegations made in the class action, Brown and the other investor plaintiffs now accuse the Fund’s auditor, Ernst & Young, L.L.P., of fraud, negligence and other misdeeds arising out of their preparation of the Fund’s financial statements.  We summarize the allegations made in the complaint and the plaintiffs’ legal theories.

    Read Full Article …
  • From Vol. 3 No.35 (Sep. 10, 2010)

    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.

    Read Full Article …
  • From Vol. 3 No.32 (Aug. 13, 2010)

    In Federal Receivership Proceedings Arising Out of Hedge Fund Collapse, Magistrate Judge Recommends that Attorney be Held Jointly and Severally Liable to Reimburse the Fund for Its Entire Loss on a Collateralized Mortgage Obligation Trade Offered to the Fund

    In 2009, the Securities and Exchange Commission (SEC) commenced a criminal enforcement action against Anthony Vassallo, Kenneth Kenitzer and their purported hedge fund, Equity Investment Management and Trading, Inc. (EIMT), claiming that the defendants had been running a $40 million Ponzi scheme.  A receiver was appointed to marshal EIMT’s assets.  In one branch of the receivership proceedings, the receiver sought disgorgement of a $2 million transfer from Veritas Investments, LLC (Veritas), a sub-fund of EIMT, to “parties in interest” Michael Callahan (Callahan) and Matthew Tucker (Tucker).  Callahan and Tucker had received, respectively, $125,000 and $1.875 million from Veritas in connection with a proposed collateralized mortgage obligation (CMO) deal.  Tucker and Callahan purportedly offered to arrange for Veritas to purchase Greenwich Capital CMOs for $2 million and re-sell those CMOs on the same day for $7 million.  Although Veritas wired the $2 million to Tucker and Callahan, and Tucker did acquire Greenwich Capital CMOs, the trade was never completed and Tucker eventually sold the CMOs at a huge loss.  The receiver sought an order forcing Tucker and Callahan to disgorge the $2 million received from Veritas.  Tucker did not oppose the motion, but Callahan did, claiming that he should only be responsible for the $125,000 he actually received.  The Magistrate Judge determined that Callahan knew or should have known that the CMO deal was a fraud and, consequently, was jointly and severally liable with Tucker to disgorge the full $2 million.  We outline the background facts and the court’s reasoning.

    Read Full Article …
  • From Vol. 3 No.28 (Jul. 15, 2010)

    New York Court of Appeals Affirms Summary Dismissal of Fraud Action by Investors in Lipper Convertibles Hedge Fund Against Its Accountant PricewaterhouseCoopers

    On June 29, 2010, the New York Court of Appeals affirmed a trial court decision to enter summary judgment on behalf of accounting firm PricewaterhouseCoopers, LLC (PwC) in ongoing litigation over its part in a fraud committed by its client, hedge fund Lipper Convertibles, LP (the fund).  The fund had intentionally overstated its assets using improper methods for valuing securities.  PwC, tasked with auditing these financial statements, fraudulently attested to their accuracy and their conformity with generally accepted accounting principles (GAAP).  Those disclosures, in turn, induced the Plaintiffs to invest in the fund, which resulted in extensive litigation once the fraud was discovered and the investors lost millions.  The Court of Appeals terminated the fraud aspect of the litigation against PwC by the investors because an overlapping, independent action against PwC, litigated by the fund’s Trustee in bankruptcy for the benefit of all investors, provided them with a direct remedy for the damages they claimed to have suffered.  We summarize the background of the action and the Court’s legal analysis.

    Read Full Article …
  • From Vol. 3 No.27 (Jul. 8, 2010)

    Update: Are There Still Avenues for Recovery in United States Courts for Overseas Hedge Fund Losses After Morrison v. National Australia Bank Ltd.?

    Just over a year ago, Christopher F. Robertson and Erik W. Weibust, Partner and Associate, respectively, at Seyfarth Shaw LLP, published a guest article in The Hedge Fund Law Report focusing on the ability of U.S.-based hedge funds to sue foreign corporations in U.S. courts for violations of the antifraud provisions of the U.S. securities laws.  See “Are There Avenues for Recovery in United States Courts for Overseas Hedge Fund Losses?,” The Hedge Fund Law Report, Vol. 2, No. 29 (July 23, 2009).  In that article, they opined that, under existing precedents, U.S. federal courts would likely apply the antifraud provisions of the U.S. securities laws to a lawsuit involving the purchase or sale of shares of a foreign company on a foreign exchange, provided American investors were substantially affected by the foreign company’s wrongful acts – even if those acts were committed exclusively overseas.  They focused on a real life example in which numerous U.S. hedge funds lost a substantial amount of money in 2008 relying on public statements that Porsche Automobil Holding SE (Porsche) made regarding its ownership interest in Volkswagen AG (Volkswagen), which resulted in a massive short squeeze that by some accounts led to over $1 billion in hedge fund losses.  They ultimately concluded that the hedge funds could assert securities fraud claims against Porsche in a U.S. court, and that such claims would not be dismissed merely because Porsche is a foreign company whose shares trade solely on foreign exchanges.  (Porsche offers limited ADRs in the United States that are seldom traded.)  Since publication of that article, several of the aggrieved hedge funds have filed lawsuits in U.S. District Court in New York alleging that Porsche violated, among other things, Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 (the principal antifraud provisions of the U.S. securities laws) by making false and misleading statements and manipulating the market for Volkswagen’s shares.  How quickly things have changed.  Just last month, the United States Supreme Court ruled, in Morrison v. National Australia Bank Ltd. (Scalia, J.), Slip Op. No. 08-1191 (decided June 24, 2010), that the principal antifraud provisions of the U.S. securities laws do not have extraterritorial reach and thus do not apply to foreign companies whose shares trade solely on foreign exchanges.  While the Morrison decision is clearly a major victory for foreign companies faced with allegations that they violated the more investor-friendly antifraud provisions of the U.S. securities laws, the decision is not necessarily as damaging as it may seem for U.S. hedge funds that were harmed as a result of Porsche’s alleged fraud.  In this update to their July 23, 2009 article in The Hedge Fund Law Report, Robertson and Weibust discuss the implications of the Morrison decision for hedge funds generally, the implications of the decision for the Porsche case specifically and the likely market impact of the Morrison decision.

    Read Full Article …
  • From Vol. 3 No.26 (Jul. 1, 2010)

    In Enforcement Action Against Investment Adviser ICP Asset Management, LLC, SEC Alleges More than $1 Billion of Improper Trades, Trades at Inflated Prices and Other Fraudulent Conduct in Connection with ICP’s Management of Triaxx CDOs

    The SEC has commenced an enforcement action against investment adviser ICP Asset Management, LLC (ICP), its broker-dealer affiliate ICP Securities, LLC, holding company Institutional Credit Partners, LLC, and their principal, Thomas C. Priore.  ICP was the collateral manager of four Triaxx collateralized debt obligations (CDOs) that invested primarily in mortgage-backed securities.  The SEC claims that ICP engaged in a variety of prohibited and fraudulent conduct, including self-dealing, breach of its fiduciary duties to the Triaxx CDOs, engaging in fraudulent transactions among those CDOs, trading to benefit one CDO at the expense of the others, and making trades that benefited another ICP client at the expense of the Triaxx CDOs.  The SEC alleges violations of the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 and seeks an injunction against future violations, disgorgement of profits and civil penalties.  We summarize the SEC’s complaint.  See also “Defunct Hedge Fund Basis Yield Alpha Fund (Master) Sues Goldman Sachs for Securities Fraud Arising Out of the Fund’s Investment in Goldman’s Timberwolf CDO,” The Hedge Fund Law Report, Vol. 3, No. 24 (Jun. 18, 2010).

    Read Full Article …
  • From Vol. 3 No.25 (Jun. 25, 2010)

    Minnesota District Court Allows Majority of Securities Fraud Action to Proceed Against Individuals and Entities that Were Affiliated with Defunct Hedge Fund Paramount Partners as Sales Agents

    In April 2009, Steven B. Cummings and a number of other investors sued hedge fund Paramount Partners, LP (Fund), its general partner Crossroad Capital Management, LLC (Crossroad), adviser/affiliate Capital Solutions Management, LP (CSM), sales agent Capital Solutions Distributors, LLC (CSD), and the respective principals of those four entities.  They alleged securities fraud, violations of various provisions of federal and Minnesota law and various common law claims arising out of the sale of limited partnership interests in the Fund.  See “Investors in Hedge Fund Paramount Partners Sue Fund, General Partner and Fund Advisers for Securities Fraud and Violation of Minnesota Law,” The Hedge Fund Law Report, Vol. 2, No. 16 (Apr. 23, 2009).  A 2009 SEC investigation revealed that, of the $10.8 million invested in the Fund over its life, investors had withdrawn $1.2 million, the Fund’s general partner Crossroad had received $2.1 million, and the Fund’s principal, John W. Lawton, had withdrawn another $900,000 directly from the Fund.  The remaining $6.6 million was either lost in trading or otherwise unaccounted for.  Defendant CSM became a minority owner of the Fund’s general partner in 2006.  CSM’s subsidiary, CSD, became the Fund’s “exclusive distributor.”  They were compensated based on the amount of capital they raised for the Fund.  CSM and CSD and their principals moved to dismiss portions of the Plaintiffs’ complaint on the ground that certain claims were time-barred and that the remainder of the complaint failed to state a cause of action against them.  The Court agreed that certain federal securities fraud claims were time-barred and that the Plaintiffs had not stated a cause of action for consumer fraud under Minnesota law.  The Court permitted all other federal and state causes of action to proceed.  We outline the court’s reasoning, with emphasis on the portions of the decision most relevant to the hedge fund industry.

    Read Full Article …
  • From Vol. 3 No.25 (Jun. 25, 2010)

    Federal District Court Refuses to Dismiss Suit Against Hedge Fund MB Investment Partners’ Controlling Persons for Ponzi Scheme Committed by MB’s President and Co-Managing Partner, Mark Bloom

    On June 10, 2010, the United States District Court for the Eastern District of Pennsylvania took the first step in dealing with the legal fallout to the hedge funds connected with disgraced hedge fund manager and convict Mark Bloom.  Bloom, as President, Co-Managing Partner, Chief Marketing Officer, and Director of hedge fund MB Investment Partners, Inc. (MB), used his influence in that firm to obtain investors for his personal investment vehicle, North Hills Management, LLC and North Hills, LP, and enhanced stock index funds through which he operated a Ponzi scheme.  Seeking restitution, a number of Bloom’s victims (Plaintiffs) brought suit against Bloom, MB, Centre MB Holdings, LLC (CMB), which owned MB and controlled its operations, Center Partners Management (CPM), which owned CMB and shared directors with MB, Robert Machinist, the Chairman, COO, Co-Managing Partner and a Director of MB, Ronald Altman, a Partner, Senior Managing Director and Portfolio Manager at MB, and seven other directors on MB’s board (Defendants).  The District Court refused to dismiss the causes of action against the officers and directors of MB, including those based on “Controlling Person Liability” under Section 20(a) of the Securities Exchange Act of 1934, as amended, and based on “negligent supervision” for their failure to properly supervise and uncover the fraud committed by Bloom, and through him, MB.  It did, however, dismiss all claims against portfolio manager Altman, notwithstanding allegations that he failed to perform due diligence in recommending the victims invest with Bloom.  We detail the background of the action and the Court’s legal analysis.

    Read Full Article …
  • From Vol. 3 No.24 (Jun. 18, 2010)

    Defunct Hedge Fund Basis Yield Alpha Fund (Master) Sues Goldman Sachs for Securities Fraud Arising Out of the Fund’s Investment in Goldman’s Timberwolf CDO

    Hedge fund Basis Yield Alpha Fund (Master) (Fund) has commenced a civil securities fraud suit against Goldman Sachs (Goldman) in the Southern District of New York.  In March 2007, Goldman created a collateralized debt obligation (CDO) known as Timberwolf 2007-1, which was allegedly part of Goldman’s efforts to reduce its exposure to the subprime mortgage market.  The Fund agreed to purchase $100 million face value of interests in Timberwolf for about $80.8 million.  Within months of the purchase, Timberwolf had declined in value by more than 80 percent, resulting in the Fund’s collapse and subsequent liquidation.  The Fund alleges that, in selling Timberwolf interests to the Fund, Goldman failed to tell the Fund that it considered Timberwolf to be a bad deal, that Goldman expected the value of CDO’s based on the subprime mortgage market to decline in value, and that Goldman was short selling both the stock of companies involved in the subprime business and the underlying CDO’s owned by Timberwolf.  Despite that, the Fund alleges that Goldman assured the Fund that the price for the Timberwolf interest was “a good entry price” and that the subprime market had stabilized.  We summarize the allegations made by the Fund.

    Read Full Article …
  • From Vol. 3 No.20 (May 21, 2010)

    Investors in Hedge Funds Managed by RAM Capital Resources, LLC Sue RAM, Its Principals and Its Funds Alleging Securities Fraud, RICO Violations and Other Claims Based on Alleged Misrepresentations and Self-Dealing by RAM Principals

    Defendant RAM Capital Resources, LLC (RAM Capital), is a New York-based asset manager that specializes in so-called “PIPE” investments (private investments in public equity).  RAM Capital matched potential investors with PIPE issuers and also formed hedge funds to invest in PIPE offerings.  Defendants Stephen E. Saltzstein (Saltzstein) and Michael E. Fein (Fein) are the principals of RAM Capital.  Saltzstein was introduced to plaintiff Stacy Frati through Saltzstein’s sister, who was a childhood friend of Ms. Frati.  Eventually Ms. Frati and her husband invested $2 million in RAM Capital’s Shelter Island Opportunity Fund, LLC.  On behalf of a client, plaintiff Banco Popolare Luxembourg, S.A. invested $1.5 million with RAM Capital’s Truk International Fund, LP.  In April 2009, plaintiffs requested redemption of their entire interests in those funds, but only $150,000 was eventually returned to Banco Popolare.  This action ensued.  Plaintiffs claim the defendants committed securities fraud, RICO violations and breach of fiduciary duty by allegedly misrepresenting the amount of personal capital they had at stake in their funds, engaging in self-dealing, charging multiple and excessive fees and failing to disclose that they were not registered broker-dealers.  Plaintiffs seek return of their investments, punitive damages, an accounting and other relief.  We detail the plaintiffs’ claims.

    Read Full Article …
  • From Vol. 3 No.19 (May 14, 2010)

    Second Circuit Upholds Dismissal of Suit by Investment Manager PIMCO Against Refco’s Attorneys, Holding that for Attorneys to be Liable for Securities Fraud as “Secondary Actors” Under Rule 10b-5, the Allegedly False Statements Must Actually Be Attributable to the Attorneys at the Time the Statements Are Made

    The United States Court of Appeals for the Second Circuit has enunciated a “bright line” standard for imposing liability on so-called “secondary actors” under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.  Lead plaintiffs Pacific Investment Management Company LLC and RH Capital Associates LLC (the Funds) lost money in the 2005 collapse of brokerage Refco Inc. (Refco).  The Funds alleged that Refco engaged in a series of sham loan transactions in an effort to conceal a substantial amount of uncollectible debt.  The Funds sued Refco, along with certain of its affiliates, underwriters and outside counsel, including law firm Mayer Brown LLC (Mayer Brown) and former firm partner Joseph P. Collins (Collins), alleging securities fraud.  Mayer Brown and Collins were involved in negotiating and drafting the documents for many of the sham loan transactions.  They also prepared a private placement memorandum and registration statements for three Refco securities offerings.  Significantly, however, none of the allegedly false statements made in the memorandum or either of the registration statements was specifically attributed to either Mayer Brown or Collins.  Those defendants moved to dismiss the Funds’ claims against them for failure to state a cause of action.  The District Court and the Second Circuit agreed, holding that the mere act of helping to prepare the allegedly false statements did not give rise to liability under Rule 10b-5.  In order for liability to attach, the alleged false statements must be clearly attributed to the secondary actors.  In addition, the court held that, because the Funds admittedly had no idea that Mayer Brown and Collins were involved in negotiating and documenting the sham transactions, they could not have relied on any actions by those two defendants.  Consequently, the Funds’ claim of “scheme liability” also failed.  This article discusses the factual background, including a review of the mechanics of the Refco fraud, and the Second Circuit's legal analysis.

    Read Full Article …
  • From Vol. 3 No.16 (Apr. 23, 2010)

    SEC Accuses Goldman, Sachs & Co. and a Goldman V.P. of Securities Fraud

    On April 16, 2010, the U.S. Securities & Exchange Commission charged Goldman, Sachs & Co. and Fabrice Tourre, a vice president on leave from Goldman, with committing fraud in the structuring and marketing of a synthetic collateralized debt obligation (CDO) linked to subprime mortgages.  See “SEC Charges Goldman, Sachs & Co. and a Goldman V.P. with Securities Fraud; Hedge Fund Manager Paulson & Co. Named in Complaint, But Not Charged with Any Violation of Law or Regulation,” The Hedge Fund Law Report, Vol. 3, No. 15 (Apr. 16, 2010).  The SEC alleges that one of the world’s largest hedge fund managers, Paulson & Co., paid Goldman to create the CDO, participated in the process of selecting subprime residential mortgage-backed securities (RMBS) to be referenced by the instruments in the CDO and then entered into a credit default swap transaction with Goldman to buy protection from credit events on specific layers of the CDO.  According to the SEC, Paulson did not violate federal securities law in its actions, but Goldman did when it thereafter failed to disclose to investors that Paulson had played a key role in developing the financial product when Paulson also had an investment that would increase in value if the CDO decreased in value.  The case represents the latest in a series of SEC enforcement actions seeking to hold firms accountable for their alleged roles in the financial crisis.  As the SEC alleged in its complaint filed in U.S. District Court for the Southern District of New York, Goldman’s actions “contributed to the recent financial crisis by magnifying losses associated with the downturn in the United States housing market.”  This article provides a detailed recitation of the key factual and legal allegations in the SEC’s complaint, and outlines Goldman’s preliminary response.

    Read Full Article …
  • From Vol. 3 No.15 (Apr. 16, 2010)

    SEC Charges Goldman, Sachs & Co. and a Goldman V.P. with Securities Fraud; Hedge Fund Manager Paulson & Co. Named in Complaint, But Not Charged with Any Violation of Law or Regulation

    On April 16, 2010, the Securities and Exchange Commission charged Goldman, Sachs & Co. (Goldman Sachs) and one of its vice presidents with defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages as the U.S. housing market was beginning to falter.  See SEC v. Goldman Sachs & Co. and Fabrice Tourre, S.D.N.Y.  The SEC’s complaint alleges that Goldman Sachs structured and marketed a synthetic collateralized debt obligation (CDO), the performance of which depended on the performance of subprime residential mortgage-backed securities.  Goldman Sachs allegedly failed to disclose to investors material information about the CDO, in particular the role that Paulson & Co., a significant hedge fund manager, played in the portfolio selection process and the fact that a Paulson fund had taken a short position in credit default swaps against the CDO.  On CLOs, a type of CDO, see “Key Legal and Business Considerations for Hedge Fund Managers When Purchasing Collateralized Loan Obligation Management Contracts,” The Hedge Fund Law Report, Vol. 3, No. 13 (Apr. 2, 2010).

    Read Full Article …
  • From Vol. 3 No.12 (Mar. 25, 2010)

    Luxembourg Court Rejects Lawsuit Brought by Investors in Defunct Luxembourg Hedge Fund LuxAlpha SICAV Against UBS and Ernst & Young in Connection with Madoff Scandal; The Hedge Fund Law Report Offers Exclusive English-Language Translation of Court Opinion

    UBS Luxembourg was the primary custodian of Access International Advisors LLC’s LuxAlpha Sicav-American Selection fund (LuxAlpha SICAV), which was closed by the Luxembourg regulator, Commission de Surveillance du Secteur Financier (CSSF), because of investments in the Ponzi scheme operated by Bernard Madoff.  Investors seeking to recoup their losses in LuxAlpha SICAV, which once had assets of $1.4 billion, brought several lawsuits against UBS.  Most recently, on March 4, 2010, a Luxembourg court rejected efforts by certain investors in the now defunct LuxAlpha SICAV to pursue a direct cause of action against UBS AG and affiliated entities, and against auditor Ernst & Young, in connection with LuxAlpha SICAV’s Madoff-related losses.  Specifically, the court found that the investors have to pursue their claims through the liquidator of their fund.  This week’s issue of The Hedge Fund Law Report includes the only available English-language translation of that opinion.  Our translation is based on the official French-language opinion, which was made available to The Hedge Fund Law Report on Friday, March 5, 2010.

    Read Full Article …
  • From Vol. 3 No.9 (Mar. 4, 2010)

    Illinois District Court Dismisses Investors’ Fraud Claims Against Hedge Fund Sitara Partners, L.P. Because of Improper Pleading and Timing of Alleged Misrepresentations

    Plaintiffs invested in hedge fund Sitara Partners, L.P. (Fund) in 2005 and 2006.  After their investment, defendant Rajiv Patel (Patel), who was the Fund’s principal, allegedly promised the plaintiffs that he had invested in a diversified portfolio of “quality securities.”  In fact, on September 2, 2008, Patel made a huge bet – 90% of the Fund’s assets – on Freddie Mac, which lost most of its value after the federal government’s takeover.  Plaintiffs lost over 75% of their investment and commenced an action against Patel and the Fund’s manager, Sitara Capital Management, LLC.  Plaintiffs alleged eighteen separate counts against the defendants for fraud, violations of both state and federal securities laws, breach of contract, breach of fiduciary duty and negligence.  Defendants moved to dismiss the entire complaint.  The court dismissed all of plaintiffs’ claims except those based on defendants’ alleged sale of unregistered securities and acting as an unregistered investment adviser.  In addition to having a poorly drafted complaint, a fundamental problem was that most of plaintiffs’ claims were based on statements that Patel made after plaintiffs had already invested in the Fund, and such statements cannot form the basis of an action for securities fraud.  However, the court gave plaintiffs leave to replead most of the dismissed claims, and essentially instructed the plaintiffs on how to survive at the pleading stage.  We outline the claims made and the court’s rationale in deciding the motion to dismiss.

    Read Full Article …
  • From Vol. 3 No.7 (Feb. 17, 2010)

    Federal Judge Approves Settlement Agreements Arising out of Marc Dreier’s Criminal Fraud; Hedge Fund Victims “Squabble” Over Proposed Recovery

    On February 5, 2010, the United States District Court for the Southern District of New York approved proposed settlement agreements and reconfirmed a restitution order for the distribution of assets from the estates of convicted swindler Marc Dreier and his law firm, Dreier LLP.  The court order responded to objections by certain hedge fund victims to those agreements, which had been reached between the United States Attorney’s Office for the Southern District of New York, the Securities and Exchange Commission, the Trustees in Bankruptcy overseeing the estates of Dreier and his firm, and two entities that had obtained proceeds and suffered losses from investing in Dreier’s fictitious notes: hedge funds GSO Capital Partners and its affiliates, and Fortress Investment Group LLC and its affiliates.  See “Affiliates of Hedge Fund Manager Fortress Investment Group Sue Dechert Over Opinion Letter Endorsing Marc Dreier,” The Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009).  We discuss the background of the various related actions – including the dispute over the disposition of Dreier’s art collection – and the court’s legal analysis.

    Read Full Article …
  • From Vol. 3 No.7 (Feb. 17, 2010)

    Arbitration Panel Awards Bear Stearns Hedge Fund Investor Racetrac $3.4 million for Claims of Misrepresentation, Negligence and Failure to Supervise

    On December 23, 2009, an arbitration panel awarded $3.4 million to Racetrac Petroleum Inc., an Atlanta-based chain of more than 525 gas stations and convenience stores across the U.S. Southeast.  Racetrac lost its $5 million investment in a former Bear Stearns hedge fund that collapsed in July 2007.  See “How Can Hedge Fund Managers Structure Their Compliance, Reporting and Disclosure Systems to Avoid Allegations of Principal Trading Rule Violations Such As Those Recently Alleged by the DOJ Against Former Bear Stearns Hedge Fund Manager Ralph Cioffi?,” The Hedge Fund Law Report, Vol. 2, No. 36 (Sep. 9, 2009).  The award amount represents only 70 percent of Racetrac’s investment, but is significant because it is the first ruling in favor of an investor in one of two now defunct Bear Stearns hedge funds since a jury acquitted the funds’ former managers of criminal charges in November 2009.  We describe Racetrac’s specific claims and the panel’s decision.

    Read Full Article …
  • From Vol. 3 No.5 (Feb. 4, 2010)

    Hedge Fund Holders of Short Positions in Volkswagen Sue Porsche and Two Top Executives for Fraud for Allegedly Lying about Porsche’s Intention to Take over Volkswagen and Allegedly Manipulating the Supply of Porsche Stock

    On October 26, 2008, Porsche Automobil Holding SE (Porsche), a European public company and German automobile manufacturer, announced that it owned directly, or had the right under cash-settled options to purchase, 74.1% of Volkswagen’s stock.  Plaintiffs are a group of hedge funds that held short positions in Volkswagen AG (VW) stock on that date.  VW’s stock price immediately rose on the Porsche announcement.  By the time Porsche went public with its VW holdings, plaintiffs’ short positions equaled more than 13% of VW’s outstanding shares.  Because the German State of Lower Saxony controlled more than 20% of VW, only about 6% of VW shares were available for purchase on the open market to cover the plaintiffs’ short positions.  A dramatic “short squeeze” ensued as plaintiffs scrambled to cover their short positions.  VW’s stock price soared from around 200 Euros per share prior to the Porsche announcement to over 1,000 Euros per share at the height of the squeeze on October 28, 2008.  Plaintiffs allege that, from as early as February 2008, Porsche lied and manipulated the market in a covert effort to accumulate sufficient options to take control of VW without paying a premium for control.  They claim that, had Porsche revealed its true intentions in the months prior to October 26, 2008, the price of VW stock would have begun to rise sooner and they would not have shorted VW stock at all or would have done so at higher prices.  They also allege that Porsche made billions in illicit profits by releasing some of its own VW shares for sale at the peak of the squeeze.  We summarize the hedge funds’ allegations and the events leading up to the dramatic October 2008 short squeeze.

    Read Full Article …
  • From Vol. 2 No.52 (Dec. 30, 2009)

    Affiliates of Hedge Fund Manager Fortress Investment Group Sue Dechert Over Opinion Letter Endorsing Marc Dreier

    On December 21, 2009, Fortress Credit Corp. and FCOF UL Investments LLC (together, Fortress) sued law firm Dechert LLP in New York state court for malpractice.  Fortress accused Dechert of issuing a false opinion letter on behalf of Marc S. Dreier, without conducting any due diligence.  Fortress claims that as a result of the opinion letter, it entered into a purported $50 million loan agreement with Solow Realty & Development Company (Solow Realty) which, in reality, was a sham arranged by Dreier to misappropriate funds from Fortress for his personal use.  (Briefly, by way of background, on May 11, 2009, Dreier pleaded guilty to a complex scheme in which, among other things, he sold fraudulent notes to investors, including various hedge funds, who collectively lost at least $400 million.  On July 13, 2009, Dreier was sentenced to 20 years in prison.  See Bryan Burrough, “Marc Dreier’s Crime of Destiny,” Vanity Fair, Nov. 2009.)  We detail the allegations in the Fortress complaint – which have yet to be proven – and the relief requested by Fortress.  The parties and allegations in the Fortress complaint – the financing unit of a hedge fund manager suing a law firm in connection with a lending transaction – recall another complaint covered in last week’s issue of The Hedge Fund Law Report.  See “Cerberus Financing Unit Sues its Former Law Firm and Two of Its Partners for $55 Million for Allegedly Giving Bad Advice,” The Hedge Fund Law Report, Vol. 2, No. 51 (Dec. 23, 2009).  The complaint also parallels other efforts by hedge fund managers (and in some cases hedge fund investors) – many of which have been unsuccessful – to seek redress from service providers for losses incurred during the credit crisis.  See “Appellate Division Upholds Dismissal of Complaint by Hedge Funds Holding More than $190 Million of Defaulted Loans Against Credit Suisse, as Arranger of Financing and Administrative and Collateral Agent, for Aiding and Abetting Fraud and Breach of Fiduciary Duty,” The Hedge Fund Law Report, Vol. 2, No. 31 (Aug. 5, 2009); “New York Court Rules that Limited Partners of Collapsed Hedge Fund Cannot Sue Fund’s Outside Legal Counsel for Fraud and Breach of Fiduciary Duty,” The Hedge Fund Law Report, Vol. 2, No. 24 (Jun. 17, 2009); “New York Supreme Court Dismisses Hedge Fund Investors’ Claims Against Prime Broker,” The Hedge Fund Law Report, Vol. 1, No. 18 (Aug. 11, 2008); “Hedge Fund Service Professionals Do Not Owe Fiduciary Duty to Investors But May be Subject to Liability for Aider and Abettor Claims if Provided by State Statute,” The Hedge Fund Law Report, Vol. 1, No. 6 (Apr. 7, 2009); “Madoff Feeder Funds Sue Casualty Insurers for Breach of Contract and Seek to Recoup Costs of Defending Against Liability Suits,” The Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009); “New York Supreme Court orders separate trial on existence of attorney-client relationship between former hedge fund principal and outside lawyer and firm,” The Hedge Fund Law Report, Vol. 1, No. 1 (Mar. 3, 2008).

    Read Full Article …
  • From Vol. 2 No.51 (Dec. 23, 2009)

    New York Supreme Court Rules that Aris Multi-Strategy Funds’ Suit against Hedge Funds for Fraud May Proceed, but Negligence Claims are Preempted under Martin Act

    Aris Multi-Strategy Fund, LP (Aris LP) and Aris Multi-Strategy Offshore Fund Ltd. (Aris Offshore) (together, Aris or Plaintiffs), two funds of hedge funds managed by Aris Capital Management, LLC, brought an action to recover over $5.13 million allegedly lost by the funds in connection with their investments in underlying hedge funds, the Horizon Funds.  Among other things, Plaintiffs alleged fraud on the part of the Horizon Funds and the indirect owner of the Horizon Funds’ investment manager.  On December 14, 2009, the New York State Supreme Court rejected a motion by the defendants to dismiss the fraud claims, finding that Plaintiff’s complaint (1) contained allegations sufficient to state a cause of action for fraud, and (2) raised factual questions sufficient to survive dismissal under New York Civil Practice Law and Rules Section 3211.  However, the court dismissed tort claims brought by Plaintiffs, finding that such claims were preempted by the Martin Act (New York State’s anti-securities fraud statute).  We detail the factual background of the case, Aris’ legal arguments and the court’s analysis.

    Read Full Article …
  • From Vol. 2 No.42 (Oct. 21, 2009)

    Billionaire Founder of Hedge Fund Manager Galleon Group, Raj Rajaratnam, Charged in Alleged Insider Trading Conspiracy

    On October 16, 2009, the United States Attorney for the Southern District of New York and the Federal Bureau of Investigation announced the filing of criminal charges against several people involved with the Galleon Group family of hedge funds and New Castle Funds, LLC, for allegedly engaging in a massive insider trading scheme.  Specifically, the government accuses Raj Rajaratnam, founder and manager of Galleon, Mark Kurland, a top executive at New Castle, and Danielle Chiesi, a New Castle employee, of contacting a network of close business associates, including Rajiv Goel, a managing director at Intel Capital, Anil Kumar, a director at McKinsey & Company, Robert Moffat, an IBM senior executive, and one another to obtain confidential information about corporate earnings and takeover activity at several public companies.  The complaints also accuse Rajaratnam of using that non-public information to illegally trade on behalf of funds under his management to obtain more than $20 million in profits.  According to federal prosecutors, this criminal action, brought in two separate, but interconnected criminal complaints, is the largest ever against a hedge fund for insider trading, and it represents the first time that the government has used wiretaps to target “significant insider trading on Wall Street.”  In a related action, the Securities and Exchange Commission (SEC) also filed a civil injunctive action in the United States District Court for the Southern District of New York against Rajaratnam, Galleon Management L.P., and the aforementioned executives based on the same allegations.  Nonetheless, this case implicates far more than just the run-of-the-mill SEC civil complaint.  Instead, as the United States Attorney remarked, it “should be a wake up call” for the entire hedge fund community.  We detail the factual allegations and legal claims in the criminal and civil complaints.

    Read Full Article …
  • From Vol. 2 No.40 (Oct. 7, 2009)

    New York State Appellate Court Reinstates Investors’ Claims Against CSAM Capital, General Partner of High-Risk Exchange Fund

    In New York, the statute of limitations for fraud is the longer of six years from the wrongful conduct or two years from when the party knew, or should have discovered, the fraud.  This particular statute of limitations was at issue in a case filed by investors against CSAM Capital, Inc., the general partner of a high-risk exchange fund, and allegedly related entities (collectively referred to as CSAM), alleging, among other things, fraud in connection with the loss of their investments in the fund.  In this action, billionaire Ronald Lauder and other investors in the exchange fund brought an arbitration claim against the fund’s general partner, CSAM Capital Inc., alleging that CSAM had fraudulently misrepresented the qualifications of the fund employees who were responsible for the fund’s hedging strategy.  We describe the allegations in the case, the factual background, the trial court decision and the First Department’s decision and legal analysis.

    Read Full Article …
  • From Vol. 2 No.37 (Sep. 17, 2009)

    Trabulse Case Illustrates a Monitor’s Considerable Discretion to Grant, Deny or Modify Investor Claims in the Wake of a Hedge Fund Fraud

    On September 26, 2007, the Securities and Exchange Commission (SEC) accused hedge fund manager Alexander James Trabulse, and various entities with which he was associated, including the Fahey Fund, L.P. (the Fahey Fund or the Fund); Fahey Financial Group, Inc.; International Trade & Data; and ITD Trading (Relief Defendants), of defrauding investors by drastically overstating the Fund’s returns and profitability.  Specifically, the SEC alleged that Trabulse sent account statements to investors in the Fund that inflated the Fund’s returns by as much as 200%, while using investor money to purchase cars and finance shopping sprees for his family members.  As a result, the SEC charged him with violating various antifraud provisions of the federal securities laws.  On December 7, 2007, the SEC obtained an order from the United States District Court for the Northern District of California that included (1) a preliminary injunction and (2) appointment of a monitor to oversee the operations of the Relief Defendants.  The SEC enjoined Trabulse from future violations of the federal securities laws and ordered that he pay $250,001 in disgorgement and penalties.  See SEC v. Trabulse, 526 F.Supp.2d 1008 (N.D. Cal. 2007).  The monitor has since allowed 115 claims, in whole or in part, totaling approximately $13.9 million.  This article discussed the claims review process crafted by the monitor, and illustrates the equitable power of a monitor to grant, deny or modify claims made by investors in the wake of a hedge fund fraud.  The case is illustrative precisely because of the typicality of certain of the claims faced by the monitor – including claims involving valuation, inadequate documentation and claimed withdrawals in excess of principal invested.

    Read Full Article …
  • From Vol. 2 No.36 (Sep. 9, 2009)

    Federal Court Dismisses Investor’s Fraud Complaint against Apex Equity Funds, Effectively Holding that SEC Rule 10b-5 Applies to the Purchase of Private Hedge Fund Interests

    Plaintiff Richard Kelter invested almost $4 million with the Apex Equity Options Fund, L.P. hedge fund (Apex or the Fund).  He alleged that virtually all of his investment evaporated when the Fund entered into a very large unhedged call contract.  Kelter sued, claiming that the Fund breached various representations about the Fund’s practices, including that his principal would be safe and that the Fund’s options transactions would all be hedged.  On August 24, 2009, the United States District Court for the Southern District of New York dismissed his complaint, holding that: (i) there were no misrepresentations made in the private placement memorandum (PPM) or prior to its issuance and, even if there were, the PPM precluded a claim based on those representations; and (ii) the alleged misrepresentations made after Kelter’s investment in the Fund could not form the basis of a claim because they were not made in connection with the purchase or sale of a security (being induced to continue to hold a security – as opposed to being induced to buy or sell a security – does not give rise to a claim).  Notably, the court did not question Kelter’s assertion that Rule 10b-5 of the Securities Exchange Act of 1934 (Exchange Act) applied to his investment in the Fund, a hedge fund.  We explain the factual background of the case, including details the PPM language, and the court’s legal analysis.

    Read Full Article …
  • From Vol. 2 No.29 (Jul. 23, 2009)

    Are There Avenues for Recovery in United States Courts for Overseas Hedge Fund Losses?

    It has become increasingly apparent that the world’s financial markets are deeply interconnected.  U.S. banks regularly lend money to foreign borrowers, foreign investors and companies invest in real estate and securities in the U.S., and American investors, in particular hedge funds, routinely buy and sell shares of foreign companies on foreign stock exchanges.  What happens, then, when a foreign company that only trades its securities on a foreign exchange commits acts that would constitute violations of the anti-fraud provisions of the U.S. securities laws, but are not necessarily violations of its own country’s securities laws, and American investors are harmed?  Do those investors have any legal remedy?  Will a court in the U.S. apply the U.S. securities laws to a case involving the purchase or sale of shares of a foreign company on a foreign exchange?  In a guest article, Christopher F. Robertson and Erik W. Weibust, Partner and Associate, respectively, at Seyfarth Shaw LLP, address these questions as they relate to hedge funds.  Their discussion includes a detailed examination of the legal consequences of Porsche’s disclosure in October 2008 that it held a majority interest in Volkswagen, and the resulting short squeeze that caused substantial losses for many hedge funds.

    Read Full Article …
  • From Vol. 2 No.23 (Jun. 10, 2009)

    Hedge Fund Promoters Lose Appeal in Eleventh Circuit, Must Disgorge $8 Million

    In May 2004, two hedge fund promoters settled with the Securities and Exchange Commission (SEC) regarding accusations of fraud in the sale of purported hedge fund interests.  The SEC waited until June 2008 before successfully moving for an order requiring the defendants to disgorge over $8.1 million plus prejudgment interest and to pay $200,000 in civil penalties.  The defendants appealed. On May 19, 2009, the United States Court of Appeals for the Eleventh Circuit upheld the disgorgement order.  We discuss the factual background and the court’s analysis.

    Read Full Article …
  • From Vol. 2 No.20 (May 20, 2009)

    Federal District Court Halts California Hedge Funds’ Alleged Fraudulent Scheme

    On April 29, 2009, the U.S. District Court for the Central District of California granted a motion filed by the Securities and Exchange Commission (SEC) to halt an allegedly fraudulent scheme in which Bradley L. Ruderman (Ruderman) conned approximately twenty investors into investing at least $38 million in his two hedge funds, Ruderman Capital Partners, LLC and Ruderman Capital Partners A, LLC (RCP-A) (together, the Funds), by misrepresenting the Funds’ stature and investment returns.  Specifically, Ruderman claimed that the Funds held more than $800 million in assets, when it fact the Funds had significantly less than $650,000 in assets.  Based on these accusations, the SEC requested and obtained a temporary restraining order and a preliminary injunction against Ruderman and the Funds he managed.  We describe the allegations in the SEC’s complaint and the district court’s action.

    Read Full Article …
  • From Vol. 2 No.19 (May 13, 2009)

    Texas Federal Court Orders Emergency Relief after SEC Accuses Connecticut-Based Hedge Funds of Fraud

    On April 27, 2009, the U.S. District Court for the Western District of Texas issued an emergency order freezing the assets of a Connecticut-based hedge fund manager, Francesco Rusciano, and the funds, Ponta Negra Fund I, LLC and Ponta Negra Offshore Fund I, Ltd., which he controls through Ponta Negra Group, LLC.  The Securities and Exchange Commission (SEC) accused the defendants of forging documents, making false promises to clients and misrepresenting the assets under management.  We outline the allegations in the SEC’s complaint.

    Read Full Article …
  • From Vol. 2 No.17 (Apr. 30, 2009)

    Registered Investment Adviser Fined For Fraud and Failure to Perform Adequate Due Diligence

    On April 22, 2009, the Securities and Exchange Commission issued an order charging investment adviser Hennessee Group LLC and its principal, Charles J. Gradante, with violations of various federal securities laws for failing to perform due diligence before advising their clients to invest in the Bayou hedge funds, a fraudulent fund that later imploded.  Pursuant to the order, the Hennessee Group and Gradante settled the SEC’s accusations by agreeing to pay more than $814,000 in fines without being required to confirm or deny their guilt.  We explain the background and practical implications of the order.

    Read Full Article …
  • From Vol. 2 No.16 (Apr. 23, 2009)

    Investors in Hedge Fund Paramount Partners Sue Fund, General Partner and Fund Advisers for Securities Fraud and Violation of Minnesota Law

    In a complaint dated April 13, 2009, Steven B. Cummings and a group of other investors who purchased almost $3 million of limited partnership interests in hedge fund Paramount Partners, LP (Paramount) accused Paramount, its general partner Crossroad Capital Management, LLC, investment adviser Capital Solutions Management, LP, sales agent Capital Solutions Distributors, LLC and their respective principals of securities fraud in connection with the purchase.  Plaintiffs alleged violations of various provisions of the federal securities laws and the Minnesota Securities Act, and various other common law claims.  Plaintiffs, who purchased their interests in Paramount between 2006 and 2008, brought this lawsuit after the SEC determined that, despite Paramount’s claim to have almost $17 million in assets at the end of 2008, it in fact had only about $1.3 million.  We detail the plaintiffs’ factual allegations and legal theories, and the related SEC action.

    Read Full Article …
  • From Vol. 2 No.16 (Apr. 23, 2009)

    Hedge Fund Manager Ordered to Pay $2.78 Million for SEC Fraud Charges

    On April 8, 2009, the U.S. District Court for the District of Massachusetts entered a final judgment on behalf of the SEC ordering United Kingdom citizen Glenn Manterfield, a principal of the Boston-based investment adviser Lydia Capital Management, to pay $2.35 million in disgorgement, almost $426,000 in pre-judgment interest and a penalty of $130,000 for securities fraud.  The order also permanently enjoins Manterfield from further violations of any of the federal securities laws.  We discuss the SEC action in the U.S., a related action in the U.K. and the court’s final judgment.

    Read Full Article …
  • From Vol. 2 No.14 (Apr. 9, 2009)

    Connecticut Court Denies Appeal by Hedge Fund Firm Promoter Charged with Defrauding Investors

    In a decision released on March 17, 2009, the Connecticut Appellate Court denied an appeal from a determination by the Connecticut Banking Commissioner (Commissioner) that the promoter of the hedge fund Criterion Investment Fund I L.P., Eddie Papic, violated various provisions of Connecticut securities laws.  Papic appealed the agency decision to the Connecticut Supreme Court, which affirmed the agency determination.  Papic appealed the latter decision to the Connecticut Appellate Court.  A panel of that Court affirmed the Supreme Court’s decision, finding that the Commissioner’s claims were not preempted by federal securities laws, that the agency findings were supported by substantial evidence and that all requisite administrative procedures had been followed.  The full Connecticut Appellate Court similarly rejected Papic’s claims.  We review in depth the Connecticut Appellate Court’s decision.

    Read Full Article …
  • From Vol. 2 No.14 (Apr. 9, 2009)

    SEC Accuses Hedge Fund Manager of Conning Investors out of $5 Million

    On March 18, 2009, the SEC commenced an action in the United States District Court for the Northern District of California against hedge fund manager Albert K. Hu, accusing him of misappropriating investor funds.  The SEC charged Hu and the entities he controls with violations of the antifraud provisions of federal securities laws.  The SEC also charged Hu individually with securities laws violations.  The SEC seeks emergency and interim relief, a final judgment permanently enjoining defendants from future violations of the antifraud provisions of the federal securities laws and an order to pay financial penalties and to disgorge ill-gotten gains.  We detail the factual allegations and legal theories advanced by the SEC.

    Read Full Article …
  • From Vol. 2 No.4 (Jan. 28, 2009)

    SEC Charges Hedge Fund Manager Arthur Nadel with Defrauding Investors Out of $300 Million

    On January 21, 2009, the Securities and Exchange Commission (SEC) accused Arthur Nadel of Sarasota, Florida, and the two investment management companies he controls, Scoop Capital, LLC and Scoop Management, Inc., with fraud in connection with six hedge funds  for which he acted as the principal investment adviser (the Funds).  We offer details of the SEC’s complaint, including the factual background and the legal allegations.

    Read Full Article …
  • From Vol. 1 No.27 (Dec. 9, 2008)

    SEC Accuses Investment Adviser of Failing to Disclose Conflict of Interest

    On September 24, 2008, the SEC filed a complaint in a Los Angeles federal district court accusing WealthWise, LLC, an investment adviser, and its owner and principal, Jeffrey A. Forrest, with fraud for failing to disclose a material conflict of interest with a hedge fund it recommended its clients invest in.  The case is a reminder of the need to fully disclose all fee sharing arrangements.

    Read Full Article …