The Hedge Fund Law Report

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

Articles By Topic

By Topic: Derivative Suits

  • From Vol. 10 No.48 (Dec. 7, 2017)

    Recent New York Court of Appeals Decision Eases Path for Investor Lawsuits Against Cayman Funds, but Certain Hurdles Remain

    When an offshore fund investor sues in a U.S. court, the defendant may argue that certain claims must be brought derivatively on behalf of the fund, rather than directly by the investor. Cayman law, which frequently governs claims involving offshore hedge funds, presents a number of potential obstacles to derivative claims, however. See “Registered Fund Advisers Delegating to Subadvisers Gain Greater Flexibility From U.S. District Court Ruling to Charge Management Fees” (Mar. 16, 2017); and “Derivative Actions and Books and Records Demands Involving Hedge Funds” (Oct. 17, 2014). Defendants have argued, and some New York courts have held, that a plaintiff’s failure to comply with Rule 12A of the Rules of the Grand Court of the Cayman Islands bars a derivative claim in U.S. courts by depriving the plaintiff of standing, whereas a Massachusetts state trial court found that the rule was merely procedural. Last month, the New York Court of Appeals decided this issue, facilitating lawsuits by Cayman fund investors in the U.S., although significant hurdles remain when bringing claims against hedge fund managers and others. In a guest article, Anne E. Beaumont, partner at Friedman Kaplan Seiler & Adelman, outlines the case history leading up to the Court of Appeals’ ultimate decision, as well as the ruling’s implications for investors, funds and managers. For additional insight from Beaumont, see “How Hedge Fund Managers Can Prepare for the Anticipated ‘End’ of LIBOR” (Aug. 24, 2017); and “Impact on Private Fund Advisers of Obama Administration’s and State Lawmakers’ Actions to Restrict Use of Non-Compete Agreements” (Nov. 10, 2016).

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  • From Vol. 10 No.11 (Mar. 16, 2017)

    Registered Fund Advisers Delegating to Subadvisers Gain Greater Flexibility From U.S. District Court Ruling to Charge Management Fees

    In 2011, five individuals commenced a derivative action in U.S. federal court on behalf of several mutual funds in which they had invested, alleging that the advisory fees charged by the investment managers of those mutual funds were excessive considering their efforts were delegated to a subadviser. On February 28, 2017, the court ruled that, in light of the type and quality of the services provided by the defendants, the management fees provided for in the applicable investment management agreements were not disproportionate and could have been the result of an arm’s-length bargain. This article summarizes the court’s reasoning and the evidence on which it is based. The decision should be of particular interest to advisers that delegate investment management services for registered funds, including alternative mutual funds, to subadvisers. Fees charged by advisers are a perennial source of regulatory concern. See “Current and Former Directors of SEC Division of Investment Management Discuss Hot Topics Under the Investment Company Act” (Mar. 10, 2016); and “PLI ‘Hot Topics’ Panel Addresses Operational Due Diligence and Registered Alternative Funds” (Dec. 10, 2015).

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  • From Vol. 8 No.44 (Nov. 12, 2015)

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

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

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  • From Vol. 7 No.39 (Oct. 17, 2014)

    Derivative Actions and Books and Records Demands Involving Hedge Funds

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

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  • From Vol. 7 No.13 (Apr. 4, 2014)

    Harbinger Group Faces Derivative Class Action Lawsuit Stemming from Alleged Fund-Raising Machinations by Philip Falcone

    Haverhill Retirement System (Haverhill) has commenced a shareholder class action and derivative lawsuit against the directors and controlling shareholders of Harbinger Group Inc. (HGI), a publicly-traded Delaware holding company once controlled by hedge funds managed by defendant Philip A. Falcone.  Haverhill claims that Falcone, facing a liquidity crunch in his hedge funds, arranged to sell a portion of his funds’ HGI shares to defendant Leucadia National Corporation (Leucadia).  In doing so, Haverhill charges that Falcone and the other named defendants had conflicts of interest and engaged in breaches of fiduciary duty, corporate waste and other misconduct when they granted seats on HGI’s board and registration rights for HGI shares to Leucadia in a deal that benefited Falcone and Leucadia, but not HGI.  See also “Important Implications and Recommendations for Hedge Fund Managers in the Aftermath of the SEC’s Settlement with Philip A. Falcone and Harbinger Entities,” The Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).

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  • From Vol. 6 No.27 (Jul. 11, 2013)

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

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

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  • From Vol. 6 No.18 (May 2, 2013)

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

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

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  • From Vol. 6 No.3 (Jan. 17, 2013)

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

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

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  • From Vol. 5 No.30 (Aug. 2, 2012)

    Hedge Fund Side Letters: The View from the Fund Director’s Perspective

    Most hedge funds are asked at one time or another by certain investors to provide side letters agreeing to preferential dealing, investment or other strategic terms.  There are clear cases where a side letter would not be acceptable, e.g., it contains plainly egregious terms; has no legitimate purpose; or is clearly contrary to what the hedge fund or hedge fund manager is doing in practice.  In most circumstances, however, there is no black and white answer as to what constitutes an acceptable side letter term or where the line should be drawn.  In crafting a side letter term that is in the best interest of the hedge fund (and in particular, other investors in the fund), there is a difficult balancing act that managers must perform.  On the one hand, the side letter can be used to facilitate a large investment that attracts other strategic investors, which could benefit the fund and the execution of its investment strategy.  On the other hand, side letters generally raise various fiduciary and other concerns that must be addressed.  In a guest article, Victor Murray, an independent accredited director at MG Management Ltd., discusses: side letter disclosure; ERISA considerations relating to side letters; unsavory terms; shareholder actions relating to side letters; lack of statutory provisions; derivative actions; fraud on the minority; and best practices in relation to directors’ review of side letters.

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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. 3 No.47 (Dec. 3, 2010)

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

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

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  • From Vol. 3 No.12 (Mar. 25, 2010)

    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

    On March 29, 2007, the San Diego County Employees Retirement Association (SDCERA) filed a lawsuit against collapsed hedge fund manager Amaranth Advisors LLC (Amaranth) and several related individuals, including the fund manager’s one-time chief energy trader, Brian Hunter, in the U.S. District Court for the Southern District of New York, alleging securities fraud, common law fraud and several other causes of action.  In essence, the plaintiff alleged that the defendants fraudulently induced SDCERA into investing in funds managed by Amaranth, then dissuaded it from withdrawing that investment with a number of misrepresentations upon which SDCERA allegedly relied to its detriment.  The recurring theme in these allegations was that defendant Amaranth represented itself as managing a multi-strategy fund with sophisticated risk management controls when in reality it operated a single-strategy fund making essentially unhedged bets.  On March 15, 2010, District Court Judge Deborah A. Batts granted the defendants’ motions to dismiss each of the several counts of the complaint.  Judge Batts ruled that SDCERA’s claim under federal securities law – that it was fraudulently induced to purchase its interests in the Amaranth fund – was unreasonable as a matter of law; that choice-of-law principles dictated that the issue of common law fraud be decided according to the law of the state of Connecticut, where Amaranth was originally incorporated; that the claims of gross negligence and of breach of fiduciary duty are derivative, not subjects for a direct cause of action, and the plaintiffs failed to satisfy the requirements for a derivative action; and that Amaranth was not itself a party to the contract – which was between the plaintiff and the fund – so the management company was not liable on a breach of contract claim.  This article details the facts of the action and the issue of whether the court had personal jurisdiction over one of the defendants, Brian Hunter, who resides in Calgary, Canada, then analyzes the court’s rationale for its dismissal of each of the counts for failure to state a claim on which relief can be granted.

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  • From Vol. 2 No.8 (Feb. 26, 2009)

    Ogier Discusses Potential Causes and Courses of Action Available to Investors in Madoff “Feeder Funds” Organized in the British Virgin Islands

    On December 11, 2008, having admitted to masterminding what would appear to have been a $50 billion Ponzi scheme through his brokerage firm, Bernard L Madoff Investment Securities LLC (BMIS),  Bernard Madoff was arrested and charged with securities fraud.  On December 15, 2008, the Securities Investor Protection Corporation commenced liquidation proceedings against BMIS and a Bankruptcy Trustee was appointed over it.  Concerned that they are very unlikely to make any significant recoveries out of the liquidation of BMIS, investors in the Madoff “feeder funds” are now looking at possible ways of recovering their losses from the feeder funds and their third party service providers such as their administrators, custodians and investment managers.  In an exclusive contributed article, Robert Foote, Managing Associate and Barrister in the British Virgin Islands (BVI) office of leading offshore law firm Ogier, explores some of the causes and courses of action that might be open to such investors under BVI law.  The discussion has particular relevance for investors in Madoff feeder funds organized as BVI entities.

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  • From Vol. 1 No.18 (Aug. 11, 2008)

    New York Supreme Court Dismisses Hedge Fund Investors’ Claims Against Prime Broker

    On July 23, 2008, Justice Charles E. Ramos of the New York Supreme Court, Commercial Division, dismissed claims brought by investors in hedge fund Wood River Partners, L.P. against the Fund’s prime broker, clearing broker and custodian, UBS Securities, LLC, for allegedly causing the Fund’s collapse. The decision suggests that under New York law, a prime broker, clearing broker or custodian of a hedge fund does not – solely by virtue of serving in any of those roles – owe a fiduciary duty to investors in the fund. The decision also suggests that state law claims based on diminution in value of a hedge fund are properly brought by the fund itself, or derivatively by its investors on behalf of the fund, rather than by investors in the fund. SeeEurycleia Partners, LP v. UBS Securities, LLC, No. 600874/07 (N.Y. Sup. Ct. July 23, 2008).

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  • From Vol. 1 No.5 (Mar. 31, 2008)

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

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

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