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Collapsed Hedge Fund $450 Million Judgment Upheld

IslandUnfortunate private investors in a Cayman Islands-based hedge fund which was marketed as low risk – but the main assets of which were revealed as ‘mere shams’ in the wake of its collapse – may get at least part of their money back after the Court of Appeal upheld a $450 million judgment against two of those involved in its management.

Various financial institutions, pension funds, charities and wealthy individuals had been lured into investing millions of dollars in the fund by marketing literature that reassured them that it was highly liquid and principally invested in global fixed income and money markets. In fact, it traded mainly in interest rate derivatives and, when Lehman Brothers collapsed and investors tried to withdraw their funds, it could not meet its liabilities. It was subsequently discovered that the fund’s largest reported assets, four swap transactions said to be worth $637 million, were in fact worthless shams.

The liquidators of an English-registered company that was closely connected to the hedge fund and had indemnified it against losses successfully sued the businessman who was the ‘leading light’ behind the fund and his wife and obtained judgment against them for $450 million against which they did not appeal.

Judgment in the same sum was also obtained on a joint and several liability basis against the marketing director and a senior employee of the English company on grounds that they should have realised that the fund was being managed contrary to representations made to investors and that they had been negligent.

On appeal, their lawyers argued that they had been as much taken in by the fund’s principal manager as investors had been. In the case of the marketing director, it was argued, inter alia, that he had no expertise in investment management. In the case of the employee – who had been the fund’s assistant investment manager – it was emphasised that it had been found at first instance that he had not given ‘dishonest assistance in fraud’ but had ‘done his incompetent best’.

Dismissing the appeal, the court upheld the first instance judge’s conclusion that both men had breached the duties that they owed the English company. In the case of the marketing director, the judge had been entitled to find that he had failed to acquire sufficient knowledge and understanding of the business and to satisfy himself as to the propriety of various transactions. He had also failed to act with reasonable care and skill in making the representations that he did to investors.

The assistant investment manager had rightly been found to have breached his fiduciary duties and had not been taken by surprise by the liquidators’ alternative claim that he had failed to act with reasonable care and skill. The court was also unpersuaded by arguments that the men’s defaults were not causative of the company’s losses.