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Representing the hedge fund investor: when a client loses money in a hedge fund because of fraud or breach of duty by a fund manager or investment adviser, you can build a solid case for compensation.

Article Excerpt
Hedge funds, once seen as investments only for the wealthy, have proliferated and become more popular among other investors. Today, an estimated $875 billion is invested in approximately 8,350 active hedge funds, and they are growing at the rate of 20 percent each year. (1)

Experts predict that investments in hedge funds will soon reach $1 trillion in assets. (2) As the volume of these investments increases, it is likely that they will generate more frequent disputes and litigation, and investors will need adequate representation. Business tort lawyers should be ready.

What are hedge funds? Typically, they are limited partnerships or offshore investment corporations comprising a limited number of investors. Domestic hedge funds commonly are organized as limited partnerships, with investors purchasing limited partnership interests.

In contrast to mutual funds, hedge fund investments are not offered to the general public. Investors are solicited on an individual basis by fund managers, broker-dealers, investment advisers, or through other one-on-one contacts. Hedge funds range from large organizations with professional staff to small entrepreneurial operations.

The term "hedge fund" derives from investment strategies of the first funds, which were established in the late 1940s. They offered investors a hedge against losses in a bear market by selling stock holdings short. Now, funds use a variety of investment strategies to offset their portfolios' exposure to market movements. (3)

Investment objectives differ from one hedge fund to the next. While some hedge funds have a reputation for achieving outsized returns, other funds have more modest goals. Many hedge funds seek a positive, absolute, market-neutral return. (4) In this sense, a hedge fund may attract investors who wish to insulate their portfolios from market volatility.

Unlike mutual funds, hedge funds may use leverage in carrying out their investment strategies. Leverage carries the risk of amplifying losses and has the potential to wipe out an entire fund.

However, hedge funds are subject to significantly less regulatory oversight than mutual funds. (5) Most hedge funds and their investment advisers are exempt from registration with the Securities and Exchange Commission (SEC). The funds can be structured to be excluded from coverage under the Investment Company Act and its regulations. (6)

By selling limited partnership interests through private placements to "accredited investors," investments in hedge funds fall under various safe harbor exemptions for private offerings, exempting the interests from registration as securities. (7) The Investment Advisers Act of 1940 requires advisers with 15 or more clients to register with the SEC. (8) The SEC's rules allow a legal organization such as a limited partnership to be considered a single client. (9)

Managing fewer than 15 funds allows an adviser to avoid registration. In 2004, the SEC promulgated regulations that would have resulted in limited oversight over hedge fund advisers under the Investment Advisers Act. (10) The Court of Appeals for the District of Columbia Circuit, however, recently vacated the regulations, leaving the regulatory climate in a state of flux. (11)

The lack of regulation has spawned debate. On one hand, hedge funds typically attract high-net-worth and sophisticated individual and institutional investors who theoretically can evaluate the risks of an investment. Yet hedge funds increasingly have sought out "retail" investors who may benefit from increased regulatory oversight.

Further, hedge funds participate in a growing share of the investment market. The collapse of Long Term Capital Management in 1998 exposed the potential for unregulated funds to affect global...

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