The 411 on Securities Litigation

The 411 on Securities Litigation

Investing in hedge funds and private equity funds can provide exposure to unique investment opportunities and are well suited to investors with the sophistication and financial well-being to understand and accept both the risks and rewards of these investments. What these investors cannot anticipate is the possibility of something really bad happening. Suddenly what once seemed like an epic story of the American Dream dissolves into an episode of “Naked and Afraid.”

Funds by their nature are largely opaque providing the investor and their advisors information upfront on the investment strategy and past performance, some information on the managers, advisors and fee structure – with periodic reporting on performance and an annual reporting package for tax preparation. What goes on behind the scenes is unfortunately not always as it should be.

Frauds are perpetrated in these types of investments at an alarming rate both in scale and in dollars involved. Some of the recent headlines include false financial reporting, valuation distortions, insider trading and the ever popular “Ponzi.”

Due Diligence

Whether you are an individual investor or a fund manager looking to diversify your holdings in a fund of funds there is no replacement for solid upfront due diligence. There are a number of templates on the web that can provide foundational data gathering on any potential investment. Two that are well done include the version from the Managed Funds Association (https://www.managedfunds.org/) or the Alternative Investment Management Association (https://www.aima.org/). It is important to note that due diligence doesn’t stop when the check clears, but rather, it is an ongoing process.

Diligence also should not be done in a vacuum, you need to understand how the potential investment fits into your particular situation, what the tax implications are and a thorough understanding of the risks and rewards. Accordingly, an accountant versed in securities and taxation as well as an attorney to review the documents are key components in a successful strategy.

Regrettably, despite the hard work and diligence, bad things happen. When they do happen, time is often of essence and decisions need to be made quickly. Here at Withum our motto for action in such circumstances is: “Preserve, Recover and Protect.”

Preserve, Recover and Protect

Preserve the attorney client privilege, by speaking with counsel first and understanding how your actions can impede the progress of the investigation. Preserve information and data (paper and electronic) that will be needed for the investigation. That will enable counsel to make appropriate determination of how to proceed with the matter, and determine whether law enforcement and or regulators need to be involved.

Recover and obtain as much data as possible (paper and electronic) including statements, offering memorandum and subscription documents to enable forensic accountants to evaluate the history of the investment, correlate the information from the fund to the relevant market and interpret the returns and the financial data provided by the fund.

Protect yourself and what remains of your investment by notifying the fund manager of your intent to withdraw and by communicating with your counsel and investigators.

Summary

An investigation of a securities matter is rarely simple and timely. Depending on the violation(s) involved, the number of investors, the type of underlying investments and the time span when the violations occurred – the complexity becomes magnified.

In instances where the issues are isolated to a single investor or small group an approach such as Financial Mediation™ can prove both cost effective and an efficient means to resolve areas of disagreement between the fund and its investors without the need for costly legal action. This, of course, assumes that the issues are not pervasive violations of law and regulations, but rather matters of interpretation.

In these instances investigators fluent in the types of investments at issue can evaluate the concerns and evidence presented by both sides and assist in the interpretation of the data and resolution of the matter, perhaps without costly litigation.

Regrettably, many instances cannot be settled and will require a team of attorneys and forensic accountants to unwind the affairs of the fund and come to appropriate determinations of damages incurred by the investors. This will very likely take an extended period of time and will often initiate separate investigations by law enforcement and regulators.

Withum’s Financial Services, Litigation Support and Tax Professionals are available to assist in due diligence for our clients before, during and after any proposed investment. When bad things happen to you, do not hesitate to seek the assistance of our experts to evaluate your situation and maximize the recovery effort.

Author: Kenneth J. DeGraw | [email protected]

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