HEDGE FUND FRAUD
PROTECT YOURSELF FROM HEDGE FUND FRAUD
Despite perceptions to the contrary, the investment firms known as hedge funds don’t always make investors lots of money. In fact, occasionally hedge funds and their management defraud investors, costing individual investors and the broader markets billions of dollars in direct and collateral losses. If you believe you have fallen victim to hedge fund fraud, contact Price Armstrong to speak confidentially with an experienced hedge fund fraud attorney.
WHAT IS HEDGE FUND FRAUD?
Hedge fund fraud is a type of investment fraud and is any act of financial misconduct committed by or for the account of a hedge fund. To understand its many forms, it helps to take a step back and explain what hedge funds are and how they function.
“Hedge funds” are investment structures in which investors pool their assets, and a manager invests those assets on the investors’ behalf for a fee. They were originally conceived as niche investing vehicles that helped wealthy, sophisticated investors “hedge” their investment portfolios against market movements by engaging in trading strategies that did not depend on which direction the markets went. Some early hedge funds gained reputations for delivering outsized returns to investors. Many more became notorious for reaping their managers extraordinary fortunes despite delivering only mediocre returns for investors.
Today, the term “hedge fund” has a looser and broader meaning than it once did. Most often, it’s used to describe any private, pooled-asset investment fund with a limited number of investors, a fee structure that pays management based on the percentage of funds-under-management plus a percentage of investment gains, and restrictive rules about when and how investors can withdraw their money. Hedge funds are lightly regulated and often use borrowed money (“leverage”) in pursuit of large returns.
Hedge funds attract investors largely based on the reputation of their managers and the secret sauce of their investment strategies. Investors put their money into hedge funds in hopes the manager’s investing magic will deliver market-beating returns. Like an exclusive club, the investing allure of a hedge fund relies heavily on:
- the fund only being open to people who meet certain financial or other criteria; and
- the difficulty outsiders have seeing what goes on inside (in terms of investment strategies).
Initially, hedge funds ensured their exclusivity by requiring large minimum investment amounts affordable only to the world’s wealthiest people. Although restrictions on who can invest in hedge funds today remain common, some investment vehicles calling themselves “hedge funds” have investment thresholds that put investing in them within the reach of a much broader slice of the investing public. As the number of hedge funds has grown and the investor base has widened, funds’ profit margins have tightened and competition has increased, creating a temptation for fund managers to engage in wrongdoing to stay in business.
In contrast to funds becoming more accessible to investors, the relative secrecy with which hedge funds operate endures. Not only do hedge funds rarely have to report their performance to the public, but even investors may have access to limited information about the fund’s investment strategies and returns under the terms of the fund’s governing agreements. This secrecy is necessary for hedge funds to operate. After all, funds can’t make money in a highly competitive investment environment without keeping their trading positions and plans mostly hidden from public view. However, a fund’s insistence on secrecy and on the supposed investing genius of its managers can also facilitate fraud on investors.
COMMON HEDGE FUND FRAUD
From the perspective of an investor, hedge fund fraud feels like putting money into a black box in reliance on someone’s promise that it’s safe there. Then the money disappears and the investor struggles to figure out what happened. Sometimes the investor’s money disappears not because of a legitimate investment decision, but because of fraudulent conduct by the fund, its management, or its employees. Some common hedge fund frauds include:
- a sham or Ponzi scheme that makes few or no investments, and instead managers outright steal investor money or use it to pay off earlier investors (such as in the case of Bernie Madoff)
- making unauthorized or “self-dealing” investments, such as investing in property or businesses controlled by the fund’s managers
- misleading investors about its investment strategy, its performance, and/or the risks involved in investing in it, in order to induce them to invest or stay invested
- wrongfully refusing to return investment capital or places unauthorized restrictions on capital withdrawals
- making illegal trades that cause it to be prosecuted and/or shut down
Hedge fund fraud can be very complicated, but investors do not need to know how the fraud has occurred to realize they’ve been scammed. In our experience at Price Armstrong, defrauded hedge fund investors most often complain of losing investment capital that just seemed to disappear into a “black box” with no explanation or accountability.
FEWER “STRUCTURAL” PROTECTIONS AGAINST HEDGE FUND FRAUD
Hedge fund fraud should never occur. It is illegal and it violates the rules governing how investment managers and brokers should behave. Those who perpetrate hedge fund fraud risk prosecution, hefty fines, and expulsion from the investment industry.
Potential punishments, however, do not always deter hedge fund fraud. In part, this may be due to the fact that it is relatively easy to start a hedge fund, as industry regulator FINRA points out, and that there are fewer regulatory controls on hedge funds than on investment funds open to the general public, such as mutual funds. As a result, it can be easier for fraudsters to launch and seek investors for a fraudulent hedge fund without detection by regulators.
DETECTING HEDGE FUND FRAUD
If regulators aren’t as reliable to protect against hedge fund fraud as they might be in connection with other investments, then how do you spot hedge fund fraud? Oftentimes the realization a fraud has occurred comes in the form of the “black box” scenario above, when a victim’s investment simply evaporates without explanation or accountability. Still, investors can look out certain indicators of fraud to steer clear of a potentially problematic hedge fund before investing in it.
Signs of hedge fund fraud:
- A fund that advertises consistent, “too-good-to-be-true,” market-beating returns, no matter the state of the markets or of the broader economy.
- An investment manager who cultivates an aura of mystery or a cult of personality around him or his firm, without giving coherent explanations of his investment strategies or the of the fund’s performance.
- Solicitations from fund management seeking new investors immediately after a market downturn.
- Investment documents that promise or guarantee returns, or that predict outsized returns over very short time periods.
- investment documents that unreasonably restrict management’s obligation to report to investors about fund performance.
- Investment documents that permit the manager to engage in “self-dealing” transactions using investor funds.
- Investment documents that make it virtually impossible to withdraw investment capital from the hedge fund.
WHEN SHOULD I HIRE A HEDGE FUND FRAUD LAWYER?
All hedge fund investors should hire an attorney who has experience in litigating hedge fund fraud matters before putting a dollar of their money into a fund. An attorney who has counseled victims of hedge fund fraud is your best bet for spotting some of the warning signs of fraud.
However, if you are already invested in a hedge fund, then call a hedge fund fraud attorney the moment you sense something isn’t right. A law firm with experience investigating and litigating hedge fund fraud cases can use its resources and legal knowledge to determine if you are right to feel uneasy about a hedge fund’s practices. You can trust the committed professionals at Price Armstrong to advise you on the appropriate steps to take to protect your rights and/or your investment.
To speak in confidence for no-charge with a skilled, sophisticated hedge fund fraud attorney, contact Price Armstrong today.
CONTACT US FOR A FREE CASE EVALUATION
If you have suffered financially because of hedge fund fraud, contact the attorneys at Price Armstrong. We can help you seek justice and protect your rights throughout the process. Call us today at (205) 208-9588 for a free initial consultation and review of your case. Let us fight for you – call now!