Tuesday, August 22, 2006

Sour grapes

Can investors who lose money in a fund sue those who make money by timing their investment better? Sound ridiculous? It does to me, but according to today's WSJ investors trying to do just that. It's a little less ridiculous because the investors in question lost money due to fraud rather than plain vanilla investment losses. Therefore, the investors that "made" money in the funds were really just the fortunate first ones out of a Ponzi scheme.

Regardless, if any of these suits were to prevail, it would set an awful precedent. In these cases, there was blatant fraud, but what about more nebulous cases? Tort lawyers are very creative, and they will comb every failed hedge fund for anyplace they can argue "negligence" or "misrepresentation."

Plus, what about investors who no longer have the money? If I put $100,000 into a hedge fund, then walk away with $300,000 and buy a nice beach house with the money, you are telling me that a judge might order me to pay back the $300,000 5 years later? Investors hate unquantifiable risks. The risk that a fund might be fraudulent is one thing. The risk that any time I make a withdrawal that someone may come after me for the money years later is entirely different.

There is a good chance these law suits will fly under the radar, because the cases involve real fraud. But I think big hedge fund managers would do well to pay attention.