Articles By Topic
By Topic: Fiduciary Duty
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From Vol. 5 No.9 (Mar. 1, 2012)
Hedge Fund Investor Accuses Paulson & Co. of Gross Negligence and Breach of Fiduciary Duty Stemming from Losses on Sino-Forest Investment
Hugh F. Culverhouse, an investor in hedge fund Paulson Advantage Plus, L.P., has commenced a class action lawsuit against that fund’s general partners, Paulson & Co. Inc. and Paulson Advisers LLC. Culverhouse alleges that those entities were grossly negligent in performing due diligence in connection with the fund’s investment in Sino-Forest Corporation, whose stock collapsed after an independent research firm cast serious doubt on the value of its assets and the viability of its business structure. Culverhouse seeks monetary and punitive damages for alleged breach of fiduciary, gross negligence and unjust enrichment. This article does two things. First, it offers a comprehensive summary of the Complaint. This summary, in turn, is useful because lawsuits by investors against hedge fund managers are rare, and particularly rare against a name as noteworthy as Paulson. Disputes between investors and managers are almost always negotiated privately, but such negotiation occurs in the “shadow” of relevant law. This article outlines what the relevant law may be. Second, this article contains links to various governing documents of Paulson Advantage Plus, L.P., including the fund’s private offering memorandum, limited partnership agreement and subscription agreement. Regardless of the merits of Culverhouse’s claim, Paulson remains a well-regarded name in the hedge fund industry. According to LCH Investments NV, Paulson & Co. Inc. has earned its investors $22.6 billion since its founding in 1994. Those kinds of earnings can – and have – purchased highly competent legal advice, which translates into workably crafted governing documents. Accordingly, the governing documents of the Paulson fund are useful precedents for large or small hedge fund managers looking to assess the “market” for terms in such documents or best practices for drafting specific terms. Thus, we provide links to the governing documents. See also “Questions Hedge Fund Managers Need to Consider Prior to Making Investments in Chinese Companies,” The Hedge Fund Law Report, Vol. 4, No. 21 (Jun. 23, 2011).
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From Vol. 5 No.7 (Feb. 16, 2012)
Recent Delaware Chancery Court Opinion Clarifies Default Fiduciary Duties Owed By Managers of Limited Liability Companies
Much confusion has arisen surrounding the scope of fiduciary duties owed by managers of Delaware limited liability companies (LLCs) to other members of the LLC. Hedge fund managers must understand the scope of such fiduciary duties because they frequently organize LLCs both as hedge funds that they manage as well as the management entities which provide advisory and administrative services to their hedge funds. As a result, hedge fund managers may owe fiduciary duties not only to hedge fund investors, but also to the other members of their management entities organized as LLCs. This article describes a recent Delaware Chancery Court opinion that clarifies the default fiduciary duties owed by managers of Delaware LLCs, as well as the scope of the ability of managers to limit or eliminate such duties by contract.
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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.
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From Vol. 5 No.3 (Jan. 19, 2012)
Delaware Chancery Court Sanctions Legendary Investor Michael Steinhardt for Trading in Occam/Calix Shares Based on Confidential Information He Received While Serving as a Representative Plaintiff in a Class Action Against Occam
In October 2010, plaintiffs Michael Steinhardt (Steinhardt), two hedge funds managed by Steinhardt, Derek Sheeler and Herbert Chen (Chen) commenced a class action lawsuit seeking to enjoin the proposed acquisition of defendant Occam Networks, Inc. (Occam) by Calix, Inc. (Calix) and challenging the fairness of the transaction. The injunction was denied and the transaction closed in February 2011, but the litigation continued. During discovery, the defendants learned that Steinhardt and Chen had traded in Occam and Calix shares while subject to a confidentiality order that prohibited trading in shares of Occam and Calix and the use of non-public information discovered in the course of the suit. The defendants moved for sanctions against them. The Delaware Chancery Court ruled that Steinhardt had violated his fiduciary duty as a class representative, dismissed him and his funds from the suit with prejudice, and imposed various sanctions on them. The Court denied the motion as against Chen. We detail the facts of the case and the Court’s reasoning.
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From Vol. 4 No.36 (Oct. 13, 2011)
Hedge Fund Healey Alternative Investment Partnership’s Complaint Against Royal Bank of Canada for Failure to Pay Full Cash Settlement Value of Equity Barrier Call Option Agreement Survives Bank’s Motion to Dismiss
Plaintiff Hedge Fund Healey Alternative Investment Partnership (Fund) purchased a cash-settled equity barrier call option from defendants Royal Bank of Canada and RBC Dominion Securities Corporation (together, Bank). The option agreement referenced a basket of financial assets, including interests in hedge funds. However, the Bank was not obligated to own those assets. In September 2008, the Bank’s monthly report on the option agreement showed its value to be almost $22 million. The Fund formally terminated the option agreement as of June 30, 2009. The Bank paid about $9.16 million to the Fund, but refused to pay any further amounts, claiming that it was unable to value certain hedge fund interests, particularly hedge fund investments held in side pockets. The Fund sued the bank, claiming breach of contract, breach of fiduciary duty and breach of the covenant of good faith and fair dealing. The Bank moved to dismiss for failure to state a cause of action. This article provides a comprehensive summary of the factual background and the District Court’s legal analysis.
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From Vol. 4 No.29 (Aug. 25, 2011)
Delaware Chancery Court Opinion Clarifies the Scope of a Hedge Fund Manager’s Fiduciary Duty to a Seed Investor
In resolving a contentious lawsuit between a start-up hedge fund manager, Michelle Paige, and her seed investor, the Lerner family, the Delaware Chancery Court issued an opinion on August 8, 2011 that described the scope of a manager’s fiduciary duty to a seed investor, and the circumstances in which a manager viably may prohibit redemption by a seed investor by lowering a gate. See “Is a Threatening Letter from a Hedge Fund Manager to a Seed Investor Admissible in Litigation between the Manager and the Investor as Evidence of the Manager’s Breach of Fiduciary Duty?,” The Hedge Fund Law Report, Vo. 4, No. 17 (May 20, 2011). This feature-length article details the background of the action and the Court’s legal analysis. The opinion is one of the longer statements to date by the Delaware Chancery Court on a hedge fund dispute, and thus provides valuable insight into the Chancery Court’s view of fiduciary duty in the hedge fund context. In addition, given the factual background, the opinion is particularly relevant to hedge fund managers that have or are seeking seed investors, and to entities that make seed investments in hedge fund managers and hedge funds. See “Ten Issues That Hedge Fund Seed Investors Should Consider When Drafting Seed Investment Agreements,” The Hedge Fund Law Report, Vo. 4, No. 12 (Apr. 11, 2011).
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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.
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From Vol. 4 No.19 (Jun. 8, 2011)
Houston Pension Fund Sues Hedge Fund Manager Highland Capital Management and JPMorgan for Breach of Fiduciary Duty, Alleging Self-Dealing and Conflicts of Interest
In 2006 and 2007, plaintiff Houston Municipal Employees Pension System (HMEPS) invested an aggregate $15 million with hedge fund Highland Crusader Fund, L.P. (Fund). The Fund was sponsored by Highland Capital Management, L.P. (Highland), which also served as the Fund’s investment manager. The Fund’s general partner was defendant Highland Crusader Fund GP, L.P. (General Partner). Defendant J.P. Morgan Investor Services Co. (JPMorgan) provided administrative support to the Fund. The Fund is now in liquidation. In a lawsuit filed in the Delaware Court of Chancery on May 23, 2011, HMEPS generally claims that, during the credit crisis of 2008, the Highland defendants and their principals “looted” the Fund with the assistance of JPMorgan and engaged in self-dealing by selling themselves high-quality assets from the Fund and leaving the Fund with junk assets. HMEPS relies in part on a whistleblower complaint filed by a JPMorgan employee who observed “questionable accounting and management practices” at the Fund. HMEPS claims that Highland, the General Partner and their principals breached their fiduciary duties to the Fund and that JPMorgan aided and abetted that breach. HMEPS is suing derivatively on behalf of the Fund. We summarize HMEPS’ specific allegations and Highland’s recent press release in response.
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From Vol. 4 No.17 (May 20, 2011)
Is a Threatening Letter from a Hedge Fund Manager to a Seed Investor Admissible in Litigation between the Manager and the Investor as Evidence of the Manager’s Breach of Fiduciary Duty?
Hedge fund manager Paige Capital Management, LLC (Fund), had a dispute with seed investor Lerner Master Fund, LLC (Lerner), over Lerner’s demand to withdraw its entire investment. The Fund’s attorney wrote a letter to Lerner “reminding” Lerner of the potential costs of litigation over Lerner’s withdrawal rights and advising Lerner that, if it did not drop its withdrawal demand, the Fund would invest Lerner’s funds in “high risk, long-term, illiquid, activist securities” and spare no expense in defending the Fund. This litigation ensued and the Fund sought to block Lerner from introducing the letter as evidence of breach of fiduciary duty by the Fund, claiming that the letter was protected both as a settlement communication and by the privilege for allegedly defamatory statements made in the course of litigation. We summarize the decision.
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From Vol. 4 No.16 (May 13, 2011)
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
Plaintiffs are Steven Mizel and his limited partnership which invested, in the aggregate, about $1.6 million with hedge fund AJW Qualified Partners, LLC (Fund). During the market turmoil of late 2008, plaintiffs sought to redeem their investments in the Fund. In response to a wave of redemption requests, in October 2008, the Fund froze all redemptions and sought to reorganize. Plaintiffs brought suit, alleging anticipatory breach of contract by the Fund and breaches of fiduciary duty by the Fund’s manager and its principal, Corey Ribotsky. The trial court denied the defendants’ motion to dismiss. The Appellate Division reversed and dismissed the plaintiffs’ complaint in its entirety, holding that the suspension of redemptions was permitted by the Fund’s operating agreement. We summarize the decision.
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From Vol. 4 No.14 (Apr. 29, 2011)
SEC Administrative Decision Holds That, For Insider Trading Purposes, Fund-Level Information, as Opposed to Investment-Level Information, May Constitute Material Nonpublic Information
In the vast majority of insider trading cases involving fund management, the material nonpublic information at issue relates to a company whose securities the fund may buy or sell. However, in a provocative recent initial decision (Decision), an SEC Administrative Law Judge (ALJ) held that information about a fund itself may constitute material nonpublic information for insider trading and breach of fiduciary duty purposes. This article explains in detail: the factual background of the Decision; the ALJ’s legal analysis; what specific categories of fund-level information may constitute material nonpublic information in the hedge fund management context; the disclosure implications of the potentially expanded scope of material nonpublic information; the interplay between the potentially expanded scope of material nonpublic information and the idea (most notably enunciated in Goldstein v. SEC) that a hedge fund is a manager’s “client”; the implications of the Decision for drafting, negotiating and performing under side letters and managed account agreements; the importance for hedge fund managers of internal investigations; how chief compliance officers (CCOs) can point to the “human toll” in this matter to capture the attention of investment personnel during compliance training; and a new category of monitoring of family relationships to be performed by hedge fund manager CCOs.
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From Vol. 3 No.29 (Jul. 23, 2010)
Sixth Circuit Rules that a Hedge Fund Adviser Can Owe a Fiduciary Duty Not Only to the Fund, But Also to Fund Investors
On July 14, 2010, the United States Court of Appeals for the Sixth Circuit upheld a conviction against Mark D. Lay for investment adviser fraud, mail and wire fraud, and for engaging in deceptive and manipulative practices relating to the Ohio Bureau of Workers’ Compensation (OBWC), which was an investor in a hedge fund he managed. The government accused Lay of ignoring a leverage cap in the OBWC advisory agreement, of failing to disclose how he exceeded that cap to OBWC, and of causing OBWC to lose $212 million as a result. For his part, Lay argued in the district court and on appeal that in his role as hedge fund adviser, he had a fiduciary duty to the hedge fund, but not to the OBWC, thereby rendering certain jury instructions at his trial improper, and invalidating his conviction on the grounds of insufficient evidence. On May 13, 2008, the United States District Court for the Northern District of Ohio rejected his motion for judgment of acquittal. The Court of Appeals affirmed that decision, holding that “Because a hedge fund adviser can, in some circumstances, have a fiduciary relationship with an investor, the jury instructions were correct and sufficient evidence supports Lay’s conviction” for investment adviser fraud. Concurring in that judgment, one judge dissented in part on the grounds that the government had failed, as a factual matter, to prove mail and wire fraud. This article summarizes the background of the action, the Court’s legal analysis, and the implications for the scope of a hedge fund manager’s fiduciary duties.
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From Vol. 3 No.10 (Mar. 11, 2010)
Identifying and Resolving Conflicts Arising out of Simultaneous Management of Debt and Equity Hedge Funds
Many hedge fund managers, especially larger ones, manage multiple hedge funds. Oftentimes, those multiple hedge funds follow different investment strategies. While management by a single manager of multiple hedge funds offers certain operational economies of scale (e.g., shared office space, personnel and technology), diversification of the manager’s revenue sources and potentially greater overall revenue, it also creates the potential for conflicts between the interests of the funds. In particular, simultaneous management by a single manager of both debt and equity funds can create a variety of information and business conflicts that challenge the manager’s ability to satisfy its fiduciary duties to both funds and both sets of investors. This issue is particularly acute now, at a time when many hedge fund managers that previously focused on equity-related strategies have launched distressed debt funds in an effort to make silk purses out of the many sow’s ears left over from the credit crisis. In effort to assist hedge fund managers in avoiding or navigating these conflicts, this article: discusses fiduciary duty as it relates to the relevant conflicts, both under Delaware law and the Investment Advisers Act; identifies specific examples of the potential conflicts, including five investment issues (e.g., consequences to both the equity and debt funds when a reorganization would benefit the debt but wipe out the equity) and two information issues (e.g., consequences to the equity fund when its manager receives material, non-public information in the course of also managing a debt fund); and evaluates the pros and cons of specific ex ante and ex post remedies for both the information issues and investment issues.
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From Vol. 2 No.34 (Aug. 27, 2009)
For Hedge Fund Managers, How Would a Statutory Definition of “Fiduciary Duty” Affect the Scope of the Duty and the Standard for Breach?
In its first meeting, the SEC’s recently convened Investor Advisory Committee identified defining fiduciary duty as one of its discussion topics. In response, four financial planning and investment advisory industry groups sent a letter to the Investor Advisory Committee opposing a definition of fiduciary duty and supporting the “workability” of the current approach which, according to the letter, involves applying common law principles to specific facts and circumstances. This debate over whether to define fiduciary duty has been given added relevance by the Obama administration’s proposal on July 10, 2009 of the Investor Protection Act of 2009 (IPA), which would for the first time define fiduciary duty by statute. See “What Precisely Is ‘Fiduciary Duty’ in the Hedge Fund Context, and To Whom is it Owed?,” The Hedge Fund Law Report, Vol. 2, No. 29 (Jul. 23, 2009). For hedge fund managers, there are two primary questions arising out of this debate: (1) to whom is a fiduciary duty owed; and (2) what is the standard for breach of fiduciary duty? The answers to these questions can dramatically alter the legal landscape in which hedge funds operate. Accordingly, this article addresses both questions, both under current law and as the law may evolve following passage of the IPA.
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From Vol. 2 No.29 (Jul. 23, 2009)
What Precisely Is “Fiduciary Duty” in the Hedge Fund Context, and To Whom is it Owed?
The concept of fiduciary duty is at the heart of the relationship among hedge fund managers, hedge funds and hedge fund investors. But until recently, “fiduciary duty” was not defined by any bill or law. Rather, it was the creature of caselaw, and much of that caselaw dealt with whether and to whom the fiduciary duty is owed, rather than the content of the duty. That has changed with the Obama administration’s proposal on July 10, 2009 of the Investor Protection Act of 2009 (IPA). While the IPA has received significant attention because it would impose a fiduciary duty on broker-dealers that provide investment advice (currently, broker-dealers are subject to a less stringent “suitability” standard), for the hedge fund community, the IPA is noteworthy as the first proposed codification of the substance of a fiduciary duty. In addition, the IPA delegates to the SEC rulemaking authority to define the “client” to whom a fiduciary duty is owed. This could empower the SEC to resolve an ambiguity that has existed since the D.C. Circuit’s 2006 decision in Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006), as to whether a hedge fund manager owes a fiduciary duty to the hedge fund itself, or its underlying investors. That is, the IPA may enable the SEC to provide by rule that a hedge fund manager owes a fiduciary duty to each investor in a hedge fund, and not just to the hedge fund itself. For practical purposes, if the IPA were to become law and if the SEC were to provide by rule that a hedge fund manager owes a fiduciary duty to hedge fund investors, it likely would become easier for hedge fund investors to sue managers based on a range of manager conduct. This is because such a law and rule would more explicitly confer standing on hedge fund investors to challenge various manager actions. In this article, we explain precisely what “fiduciary duty” means in the hedge fund context, and explore to whom the duty is owed (the answer is by no means straightforward). We also explore: the practical consequences of identifying either the hedge fund or its investors as the manager’s “client”; Investment Advisers Act Rule 206(4)-8, the anti-fraud rule with a negligence standard; whether fiduciary duty can be waived; the definition of “client” in the Private Fund Investment Advisers Registration Act of 2009; and the executive compensation provisions of the IPA.
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From Vol. 2 No.24 (Jun. 17, 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
In the continuing saga over the 2005 collapse of Wood River Partners, L.P. (the Fund), which suffered huge losses by reason of its highly-concentrated bet on Endwave Corporation (Endwave), New York’s highest court affirmed the dismissal of a complaint filed by limited partners of the Fund against Seward & Kissel, LLP (S&K), which served as outside legal counsel to the Fund. The Court of Appeals held that the limited partners failed to plead the alleged fraud by S&K with sufficient particularity. It also ruled that outside counsel to a limited partnership owes a fiduciary duty only to the partnership itself, not to its individual limited partners. We provide a detailed discussion of the facts of the case and the court’s legal analysis. The case offers a rare statement on hedge fund law from the highest court of a U.S. state in which many hedge funds are domiciled, and in which the vast majority of hedge funds conduct business. As such, the case includes important and widely-applicable insights on the scope of a hedge fund manager’s fiduciary duty, and the limits on the potential liability of service providers to hedge funds.
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From Vol. 1 No.8 (Apr. 22, 2008)
Federal Court Holds that Trader’s Role as Hedge Fund Manager Does Not, by Itself, Create Fiduciary Duty to Fund's Investors
- Hedge fund trader’s motion to dismiss manager’s breach of fiduciary duty claim denied, since state law requires that parties to a joint venture owe one another such a duty, and allegations that trader recklessly acted to shut the fund down would constitute a breach of such duty.
- Trader’s motion to dismiss manager’s breach of contract claim also denied, since complaint adequately alleged that trader caused two unsatisfied “day trade calls” that remained unsatisfied during the relevant period.
- Investor’s claim that trader breached fiduciary duty dismissed because investor failed to show he placed his “trust and confidence” in trader.
- Investor’s claim that trader tortiously interfered with contract dismissed for failure to allege that trader intended to harm investor.