How Hedge Fund Managers Can Use Arbitration Provisions to Prevent Investor Class Action Lawsuits

As can be expected during an economic downturn, hedge fund managers were not impervious to investor dissatisfaction following the 2008 financial crisis.  In some instances, this dissatisfaction resulted in litigation.  A recent trend is for investors to threaten to bring their claims as a class action, which not only carries the possibility of exponentially increasing potential damages, but also harming the reputation of the manager and its ability to raise capital in the future.  Nearly all fund governing documents contain arbitration provisions that require any and all claims relating to investment accounts to be arbitrated in private, confidential proceedings.  However, most arbitration provisions contained in fund governing documents are silent on the availability of class arbitration, and this issue is significant for hedge fund managers to consider both retrospectively and prospectively in drafting their governing documents.  While the issue of the permissibility of class actions in arbitration has been the subject of recent judicial scrutiny, reported cases have not yet applied the issue to the hedge fund industry.  In a guest article, Joshua G. Hamilton and Adam M. Sevell, partner and associate, respectively, at Paul Hastings, consider the interplay of recent court opinions dealing with the limitations on class action arbitrations and whether class actions should be permitted in the context of disputes between an investor, on the one hand, and a hedge fund and its manager, on the other hand, and offer some best practices for hedge fund managers seeking to preclude class arbitration.

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