The Atlanta Journal-Constitution reported today that an Atlanta hedge fund manager is being sued for fraud by investors who contend that he diverted money for personal use and falsified financial statements to hide the theft. This is just one example of the problems that can arise when investors ? particularly those who are unsophisticated ? invest in hedge funds. Though similar to mutual funds in that they pool investors’ money to invest in a variety of financial instruments, they are generally not required to register with the Securities and Exchange Commission (SEC). Hedge funds typically issue securities in “private offerings” that are exempt from SEC registration requirements because they can only be offered to a limited number of accredited investors.
“Accredited” means that the investor meets certain income or net worth requirements. The present rule is that an individual investor must have a net worth in excess of $1 million, or income in excess of $200,000 per year for the last two years ($300,000 for a couple), in order to accredited for participation in hedge funds, private placements, or other so-called “Reg D” offerings. A common abuse of hedge funds as well as other private offerings is that they are sometimes offered to investors who do not meet these criteria. Because hedge funds typically employ leverage and other risky investment strategies that are unsuitable for many retail investors, a certain level of sophistication is required before an investor should entrust his or her life savings to a hedge fund manager?not only from a risk tolerance standpoint but in order to be able to understand financial statements and comprehend what the fund manager is doing with the money. Furthermore, valuation of fund assets can be very difficult to understand since many funds invest in illiquid securities that are difficult to value, and hedge funds often give themselves considerable discretion in how they value securities. Before investing in a hedge fund, investors are urged to read the fund’s prospectus or offering memorandum carefully, to understand how the fund’s assets are valued, to understand how the fund earns its fees, to understand what restrictions there are on the right to redeem shares, and to research the backgrounds of the fund managers. Since hedge funds often require significant investments, it may even be prudent to have the offering documents reviewed by counsel, an accountant or an independent financial adviser.
Hedge fund managers owe their investors the same fiduciary duty owed by any investment adviser to any customer. Accordingly, the hedge fund manager has a duty to make investments that are in the best interests of the fund and not in the manager’s own personal interests. Fund managers cannot make false or misleading statements about the fund’s investments or how the fund is managed. All fees and fund restrictions must be properly disclosed. Managers cannot puff their resumes or otherwise misrepresent their experience. Misrepresentations can give investors a right to sue fund managers if the fund turns out to be something other than the way it was represented.
According to Craig T. Jones, an attorney with the Atlanta law firm of Page Perry, “investors cannot expect regulators to protect them from hedge funds because they are usually not subject to close SEC scrutiny. While regulators may become involved in the most egregious cases, most fraud by hedge funds managers probably takes place beneath the regulatory radar. If you believe that you have been the victim of hedge fund fraud, it would behoove you to consult a lawyer who is experienced at recovering losses for defrauded investors.” Jones’ law firm, Page Perry, is based in Atlanta but represents investors in securities fraud cases all over the country. “If you give us a call,” says Jones, “we can review your situation and advise you with respect to any possible claims you may have.”