Tips for Hedge Fund Investors from Your Investment Arbitration Lawyers
Although hedge funds are not required to register with the SEC, they remain subject to the same prohibitions against investment fraud as other market participants, and managers have the same fiduciary duties as other investment advisers. Unfortunately, more than a few fund managers have been enticed by the lack of mandated reporting to take advantage of those who entrust them with their investment assets.
As with any investment opportunity, investors should fully understand the myriad risks associated with hedge funds before making an initial investment. Conducting appropriate due diligence is critical. Such fundamental research should include:
- Reviewing www.sec.gov for past regulatory actions against the fund manager;
- Reviewing state securities agencies’ web sites for complaints;
- Reviewing federal district, bankruptcy and appeals court records through www.uscourts.gov/courtlinks
- Locating and speaking with fund administrators and noting their independence;
- Ensuring that a reputable independent accounting firm performs an annual audit.
Considering the sizable investment one must make to participate in most hedge funds, hiring a professional due diligence firm to perform a more thorough background check is a smart investment itself to further safeguard against potential fraud victimization.
While the SEC can take action against fraudulent funds, investors must also remain vigilant for signs of misrepresentations and outright fraud. Some common areas of concern are misrepresentations about the advisors’ professional experience and the fund’s investment record. Our securities fraud law firm has also seen an increase in the number of hedge fund fraud cases where the types of risks, investment strategies, and the amount of leverage itself has been improperly conveyed.
Our FINRA arbitration attorneys note that Ponzi schemes have also been used to lure investors to hedge funds, often with devastating results. While early investors are paid interest to give an air of legitimacy and avoid arousing suspicion, later investors are not so fortunate. With some of these more nefarious hedge funds even distributing fraudulent account statements to keep investors in the dark regarding their fund’s true status, the money is often long gone by the time the scheme is uncovered.
The SEC and the Commodity Futures Trading Commission have identified several indicators of hedge fund fraud:
- Lack of trading independence – hedge fund managers trading through affiliated broker\dealers;
- Investor complaints – investors being unable to redeem their investments in a timely fashion;
- Audit issues – lack of audits by reputable independent accounting firms
- Litigation – civil suits and securities arbitration cases against hedge funds filed by investors alleging fraud; Unusually strong performance claims – hedge fund performance claims are better than market average over a long period of time;
- Illiquid investments – investing in a commodity which is not easy to value (incentive to overvalue investment in order to earn a larger commission);
- Valuation issues – use of related parties to value illiquid investments or use of a non-independent fund administrator;
- Personal trading – hedge fund managers trading in their own accounts;
- Aggressive Bear Shorting – hedge funds take a short position in a stock (betting it will go down) and orchestrate efforts to disseminate unfounded or materially false negative information about the stock, eroding the price and allowing the perpetrators to profit on the short position.
The SEC has implemented new rules to prevent naked short selling of financial services companies’ stocks
Click here for an example of hedge fund fraud provided by the SEC.
If you have already invested in a hedge fund there are several steps you can take to monitor for hedge fund fraud:
- Thoroughly read and understand the fund’s prospectus and memorandums;
- Be an active investor – engage fund managers by asking questions and taking notes;
- Save all documentation;
- Consult an attorney before signing any investment commitment;
- Take special care about navigating redemption and litigation rights;
- Do not rely on a set static checklist – different funds can employ radically varying investment strategies, and must be judged individually;
- Look closely at the fund’s transparency, third-party pricing, quality and control of its investment professionals, and internal processes.
What to Do if you Suspect Fraud
Investors suspecting hedge fund fraud are strongly encouraged to contact a securities attorney to best protect their rights and their assets. The investment arbitration lawyers at Zamansky LLC have the resources, expertise, and experience to represent clients with significant and moderately sized claims.