The term Hedge Funds are undefined under federal or state securities laws. However, hedge funds are generally pooled investments. Interests in these investments are generally sold as partnerships, or in the forms of memberships interest in a Limited Liability Corporation or LLC, with the general partner, or the managing member managing the hedge fund’s investment portfolio, making investment decisions, and generally having financial interest in the fund and its performance.
While there are many types of hedge funds, hedge funds generally seek the absolute returns, which generally means that hedge funds target a specific range of return and attempt to produce these targeted returns irrespective of underlying trends of the overall stock market or asset class.
To obtain these returns, hedge fund managers trade sophisticated investments, including for example derivatives. currency or commodities futures, and may use sophisticated investment techniques such as short selling, and arbitrage. Hedge funds can also be leveraged, they may purchase concentrated positions in securities of one issuer, they may invest in distressed or bankrupt companies, or non-marketable securities, including private bonds or notes.
According to a research report by McKinsey & Company, the Assets Under Management for global alternative investments have grown to a record $6.5 trillion, having grown at a five-year rate of more than seven times that of traditional asset classes.
Typically hedge funds charge an annual management fee of 2 percent, and also generally receive performance fees of 20 percent.
Because these funds are sold as private placements to generally accredited investors, while they are still subject to the anti-fraud provisions of the federal and state securities laws, they are not required to file registration statements with the US Securities & Exchange Commission. Also because of their private nature, and the freedom to make any investment consistent with the funds stated investment objectives, unlike mutual funds, generally, hedge funds are not subject to liquidity or over concentration requirements. However often, certain of these interests may not be readily redeemable, and their value, based upon the ownership of non-marketable private investments may also not be transparent.
Many claims against hedge funds include investment objective drift, where the fund, at least in its private offering materials, purports to invest in certain types of securities, although complex, generally marketable securities. Funds may also purport to limit their exposure or investments in non-marketable securities or other types of investments. However, sometimes, unbeknownst to its investors, the stated investment objective or objectives may be false, or may change or devolve to include other riskier investments.
Many times, a hedge fund’s decision to purchase a particular investment for the fund may be the product of a material conflict of interest in that these purchases may not be at arm’s length with a related entity, or may be effected as an exit strategy or to confer a benefit upon other groups of investors or the fund manager itself. We have seen cases where a hedge fund manager purchased inflated real estate using a 1031 exchange to establish the cost basis, and another case where the fund manager purchased and exercised warrants in a related company using fictitious valuations. Many times, unfortunately, the hedge fund may just be an elaborate Ponzi scheme, never having made any of the contemplated investments.
Generally hedge fund claims can include fund raising claims in the form of private lawsuits by investors against the hedge funds and their managers alleging that investors were induced to invest fraudulent and misleading material misrepresentations as to the fund’s investment strategy, the experience or past success of the fund managers, breach of fiduciary duties to the fund, or the failure to disclose conflicts of interest.
Claims can also include management claims also in the form of private lawsuits by investors as to whether the hedge funds and their managers followed the fund’s investment parameters, accurately reported fund actual value or performance, or prudently, as the result of some form of due diligence, invested the funds under management.
Most often where investors lose all or most of their investment, the funds are out of business, the investment managers may be off to jail, and other than any modest funds which may be seized by the government to be distributed to injured investors, there is no likely source of recovery against any solvent entity on behalf of investors. However, most often, these investors may have claims against the stockbroker or investment advisor that recommended or solicited investments in these hedge funds based upon insufficient or non-existent due diligence, the failure to spot ref flags or warning signs, or to validate often attainable or bogus investment returns.
Guiliano Law Group
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