Hedge funds are an increasingly popular investment tool, often suggested as an alternative to other pooled fund investments.
However, because the Securities and Exchange Commission (SEC) provides less regulation over them, hedge funds carry a greater risk. Over the past two decades, investors have lost billions of dollars to fraud involving hedge funds.
As an investor, it is important to be aware how hedge funds operate and how they can be fraudulent. If you believe you’ve been the victim of investment fraud, contact an investment fraud attorney right away. They can assess your case and advise you on your potential options for recovery.
What Is a Hedge Fund?
Simply put, hedge funds are a type of investment partnership. Like a mutual fund, a hedge fund is built from the pooled funds of many different investors. These investors give their money to fund managers, who invest it according to the fund’s overall objectives.
Hedge funds are an attractive option to many investors because they are more aggressively managed than other investment vehicles. Hedge funds invest in a variety of non-traditional assets beyond stocks and bonds, including foreign currencies, real estate markets, and even derivatives.
This kind of investment strategy does have its benefits. At the same time, however, the enormous complexity of hedge funds makes them a higher risk. Investors may not know exactly how their money is tied up at any given time.
What Is Hedge Fund Fraud?
There is no single way that hedge fund managers defraud investors. Instead, hedge fund fraud can take the form of several common types of investment scam, including:
- Insider trading for the personal benefit of the hedge fund managers;
- Securing an investment through misrepresentations about about the investments within the fund or its promised returns;
- Securing your investment without properly disclosing the risks of the fund; and
- Hiding investment losses.
Occasionally, a hedge fund covers up an outright investment scam from the beginning. Bernie Madoff’s infamous Ponzi scheme, for example, involved a hedge fund. Many hedge funds are legitimate, but investors must always be wary of who is managing their money.
What Are the Signs of Hedge Fund Fraud?
As with other types of investment fraud, hedge fund fraud can take a number of forms. In general, however, if the promises made about a hedge fund seem too good to be true, they probably are.
No two hedge fund fraud cases are exactly alike, but there are several red flags you can look for. When researching a potential investment, pay attention to
- Promises of excessive returns;
- Promises of consistent returns regardless of market strength;
- Vague or complicated communication about your investment;
- Whether an independent accounting firm regularly audits the fund; and
- Whether the fund has a balance of liquid and illiquid investments.
In addition, the conduct of a hedge fund manager is a good way to judge the legitimacy of a hedge fund. Unlike brokers at a brokerage firm, hedge fund managers do not receive commissions for the securities they sell.
Instead, reputable hedge funds charge a management fee of between 1% and 4% of the total assets managed and a performance fee based on the total profit the fund generates. If you plan to invest in a hedge fund and the manager indicates that they are paid on commission, it’s probably best to stay away.
Why Is Hedge Fund Fraud So Common?
Hedge funds have two primary characteristics that make them a prime target for investment fraud. First, compared to other investments, hedge funds are relatively unregulated. And second, hedge funds involve larger investments and wealthier investors.
Hedge Funds Operate with Less Oversight from the SEC
Hedge fund fraud is more common because hedge funds operate with less oversight from the SEC. The SEC requires certain types of investment companies to register with the Commission before commencing operations.
As a condition of registration, these companies must file certain reports with the SEC. This additional oversight makes it harder for these regulated investment funds to engage in fraudulent behavior.
Hedge funds organize themselves as private investment limited partnerships so that they fall within an exception to these registration requirements. This exception allows hedge funds to operate without registering with the SEC and exempts them from the same mandatory reporting requirements as registered investment companies.
Hedge Funds Involve More Money Compared to Other Funds
Hedge funds are a common target for investment fraud because they involve investors with a higher net worth than in other pooled funds.
Compared to other types of investments, hedge funds require sizable upfront investments to join. What’s more, the SEC permits only accredited investors to trade in unregistered securities.
The SEC considers an investor to be “accredited” if they have an individual income in excess of $200,000 per year or a net worth of more than $1 million. In August 2020, the SEC amended the definition of “accredited investor” to include investors that meet certain minimum thresholds of professional knowledge, experience, or certifications.
In a sense, accredited investors are those that the government believes are sophisticated enough to make riskier investment decisions on their own.
However, even diligent and knowledgeable investors may fall victim to particularly clever investment fraud schemes. Unscrupulous hedge fund managers know this and may see these wealthy investors as an opportunity for fraud.
Should I Hire an Investment Fraud Attorney?
If you’ve suffered investment losses after investing in a hedge fund, it is important to speak with an investment fraud attorney right away. As an investor, there are a number of legal theories on which you can rely to hold a hedge fund and its managers liable for your losses.
For example, even though hedge funds are not required to register with the SEC, hedge fund managers are still investment advisers obligated to act as fiduciaries to their investors.
As fiduciaries, hedge fund managers owe both a duty of loyalty and a duty of care to their investors Thus, in addition to claims for misrepresentation, breach of contract, or other theories of liability, hedge fund managers are open to claims for breaching their fiduciary duties.
Experienced investment fraud lawyers are familiar with the types of claims investors have. They will know what evidence you need and the best way to build your case.
By hiring an investment fraud attorney, you can minimize future losses and maximize your recovery. Even if you’re unsure whether you have a claim, don’t hesitate; investment fraud attorneys, including our firm, offer a free initial consultation to discuss your case.
Did You Lose Money to Hedge Fund Fraud?
The Law Offices of Robert Wayne Pearce, P.A., have been representing investors for over 40 years. If you’ve lost money to a fraudulent hedge fund, you may be able to recover some of your losses. Contact us today or give us a call at 561-338-0037 for a free consultation.