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
Hedge Fund Law Report
On December 1, 2010, the U.S. Court of Appeals for the Seventh Circuit affirmed a pro rata distribution plan for the liquidation of a family of investment vehicles, akin to hedge funds, over the objections of investors who claimed that their pre-receivership redemption requests gave them creditor-priority over non-redeeming investors. The appeal arose out of an enforcement action by the U.S. Securities and Exchange Commission (SEC) against the collapsed management firm, Wealth Management LLC, and its six investment vehicles. The U.S. District Court for the Eastern District of Wisconsin had appointed a receiver to take over and liquidate the defendants. The objectors, non-parties to that action, claimed that the receiver’s liquidation plan illegally failed to recognize their rights, as equity investors who sought to redeem their shares prior to the funds’ collapse, to have their interests converted into corporate debt with liquidation priority over other non-redeeming equity investors. The Circuit Court agreed with the District Court, ruling that the liquidation plan, which subordinated their interests in order to treat all investors equally, only needed to allocate receivership property in a manner that is “fair and reasonable” to all investors, and that state law did not govern the distribution. We detail the background of the action and the Court’s pertinent legal analysis.