Fri, 01/08/2008 - 05:00
The problems faced by many sectors of the alternative investment industry are being shared with the law firms that service them (Cadwalader, Wickersham & Taft has just announced nearly 100 redundancies) but it's safe to say that litigation departments are probably being spared. As investors become increasingly ready to sue over hedge fund losses in particular, service providers all over the world will be hoping that a US court's rejection of a claim against UBS in its capacity as a prime broker and custodian to a failed fund will ward off potential claimants looking for defendants with deep pockets.
Providing some respite for the beleaguered Swiss banking giant, a New York Supreme Court judge has dismissed a lawsuit alleging that UBS was responsible for regulatory failings on the part of a now-defunct hedge fund for which it acted as prime broker and custodian.
The plaintiffs, who had invested a total of USD79m in Wood River Partners, claimed that UBS was aware that the fund had accumulated a large shareholding in a loss-making company, Endwave, but had failed to report its stake as required to the Securities and Exchange Commission.
Far from disclosing the stake itself, or withdrawing as prime broker, the investors alleged, UBS manipulated the market in Endwave stock to suit its own ends. They claimed the bank borrowed from the Wood Rivers Partners account to sell Endwave shares short and helped other UBS clients do the same, resulting in a decline in the value of the fund's portfolio.
However, UBS said it was not directly accountable to the plaintiffs and moved to dismiss the complaint, which was filed in May 2007. The bank was supported by the judge, which ruled that it did not owe a duty of care to the fund's investors.
"Plaintiffs merely assert that, by virtue of UBS's position as prime broker, clearing broker and custodian for the fund, UBS assumed a fiduciary duty to the plaintiffs, as limited partners," the judge ruled. "These allegations, without more, are not sufficient to establish the existence of a fiduciary relationship."
This ruling sets down a precedent for any future litigation by investors alleging negligence o malfeasance against fund service providers, especially prime brokers. It might also explain why investors in the defunct Bayou Management hedge funds, who have filed a lawsuit against prime broker Goldman Sachs, are seeking a mere USD20m from the world's largest investment bank.
Hedge fund service providers do not automatically have a fiduciary responsibility to their clients' investors - a judgment that undoubtedly will have many prime brokers sighing with relief.
Often missed or played down in many media reports and analyses, cutting costs through paying less tax is an important feature of financial sustenance for many companies. And this concept is gaining even more ground as firm struggle to meet their profit expectations amid these turbulent markets.
Hedge funds are no different, and the latest substantial increase in the number of funds registered in the Cayman Islands - a virtually tax-free jurisdiction - underline the importance of the role played by tax in the alternative investment industry.
At the end of June, 10,037 funds were registered in Cayman, up from 9,413 at the end of last year, according to the industry regulator, the Cayman Islands Monetary Authority. This increase comes despite a year-long credit crisis that has slashed returns for many hedge funds and cut both capital inflows and the number of new funds launched in North America and Europe.
US and European hedge fund managers set up investment vehicles in Cayman to attract global investors, as it is often more tax-efficient for them to invest in offshore vehicles than in domestic hedge funds. The same applies to US-based non-taxpayers such as educational endowments.
Cayman continues to face regular verbal harassment in the US Congress over its alleged role in encouraging tax avoidance or evasion, but it has done nothing to constrain the steady flow of new funds being established in the jurisdiction. The leading offshore hedge fund domicile for nearly a decade, it continues to outpace comfortably rival jurisdictions such as the British Virgin Islands, Jersey, Bermuda and Guernsey.
For all the efforts of European countries to encourage the establishment of hedge funds at home, there's no sign that Cayman's dominance will be challenged any time soon.
Dozens of hedge funds are reported to have received subpoenas from the Securities and Exchange Commission as it investigates rumours that have battered the share price of Lehman Brothers in recent weeks.
The SEC, which is focusing on four specific rumours that may damaged the investment bank's credibility in the market, according to the Wall Street Journal, has asked the funds for transcripts of phone calls, messages and payroll documents that mention the Federal Reserve's lending facility, Barclays, hedge fund SAC Capital Advisors and fixed-income manager Pimco.
The investigation into potential market manipulation involving rumours about Lehman's supposedly deteriorating financial health followed the near-collapse of another investment bank, Bear Stearns, which was the target of similar rumours and was sold in extremis to JPMorgan Chase when it appeared that it would be unable to find financial counterparties with which to trade.
Europe has seen similar cases. The UK's Financial Services Authority recently launched an unprecedented investigation into dealings in the shares of major financial institutions trying to raise capital from shareholders amid suspicion that speculators have been spreading false rumours to force down the value of shares in mortgage bank HBOS.
However, hedge funds and other traders retort that some of the rumours have turned out to be true. For example, the subscription rate for HBOS's capital-raising turned out to be meagre, with less than 10 per cent of shareholders backing the rights issue.
Rumours have always played a part in financial markets, and the authorities on either side of the Atlantic have yet to find hard evidence that they are being deliberately used to manipulate markets or ruin financial institutions.
The era of the baby boomer - a loosely defined term, but usually understood to encompass those born during the post-World War II baby boom between 1946 and the early 1960s - is coming to an end. Since the late 1990s, there has been a growing debate about how this generation will manage the latter part of their lives, and some commentators argue that baby boomers are in a state of denial regarding their ageing and eventual death.
But one person's declining years are another's financial opportunity, and at least a couple of hedge funds are now focusing on opportunities related to the gradual departure of the baby boomer generation from this world by taking stakes in companies that operate funeral home and cemeteries, which can expect to see their business grow in the coming years and decades.
SAC Capital Advisors recently acquired a further 2 million shares in Houston-based Service Corporation International, the biggest funeral home, cremation and cemetery operator in the US, taking its stake to 2.2 per cent; it also holds 6.1 per cent of the company's biggest rival, Stewart Enterprises, which Service Corporation has just launched a USD1bn bid to acquire. Quantitative hedge fund firm AQS Capital Management is also reported to have increased its stake in Service Corporation.
The US mortality rate, which was 8.1 per thousand two years ago, is forecast to rise to 9.3 per thousand by 2020 and 10.9 per thousand in 2040, according to the National Funeral Directors Association. Service Corporation expects that the increased death rate of boomer generation members may begin to boost its business in as little as five years, and the expanding market can only help its share price.
James Love of BoomerDeathCounter.com calculates that a US baby boomer will die every 48.2 seconds during 2008. For those hedge funds that have bet on firms like Service Corporation, it's an ill wind...
Troubled hedge fund Absolute Capital Management has closed one of its hedge funds and its office in Mallorca as poor performance and a big loss for the year cast a shadow over the firm's efforts to reinvent itself following the abrupt exit of co-founder Florian Homm last September.
Aim-listed Absolute Capital, which is legally domiciled in the Cayman Islands but operates from an office in Zug, Switzerland, last week reported a pre-tax loss of EUR32.9m and warned that possible legal claims over losses suffered by its hedge funds could leave it without the resources to keep trading.
The hedge fund manager could see its assets under management, which were estimated at some EUR706m at the end of April, reduced once a lock-up period for several funds ends in November, although the company says it has received informal indications from various large investors that they are "amenable to remaining invested" in its products. Absolute Capital has closed its office in Mallorca, where Homm had based himself.
Nevertheless, the firm's executives say they remain optimistic. "There's a business here," said chief executive Glenn Kennedy. "In spite of what happened with Florian, there are still a number of very loyal investors in the group."
Chairman Jonathan Treacher added: "From January to June, performance has been okay. We haven't been trying to shoot the lights out. We've been trying to stabilise the business and focus on assets."
Perhaps this goes to show how much influence one person can have on a company's performance. Since Homm left, it has been tough going for the firm, which uncovered up to USD550m in investments in highly illiquid US penny stocks following his departure. No direct replacement has been found for Homm. Treacher suggested AbCap would look for more new managers, possibly to be incentivised with equity awards, once the business had recovered further.
Still, the role played by Homm - whose departure began a downward spiral for Absolute Capital's share price - may not have been as significant as the timing of his exit, just two months after the onset of the credit crunch.
Prime minister Manmohan Singh won a vote of confidence in India's parliament last week with a comfortable margin. The opposition had demanded the premier's resignation after three MPs alleged they had been bribed to abstain, but the government won the vote 275 to 256, ensuring the immediate survival of the ruling coalition and of a civilian nuclear deal with the US.
Now the government can move ahead with the deal, which would draw India closer to the West and allow it access to foreign civilian nuclear fuel and technology, despite its failure to sign the Nuclear Non-Proliferation Treaty and its conducting of nuclear tests in 1974 and 1998. According to an Indian business lobby group, the deal could unlock USD40bn in investment over the next 15 years, as India seeks new energy sources to tap its booming, trillion-dollar economy.
It would be an understatement to say that hedge funds' interest in India will be amplified with the establishment closer ties to the West. But more importantly, the focus on alternative energy, the demand in emerging markets such as India and the high return on investment that could be generated from nuclear power investment will undoubtedly catch the notice of many hedge funds.
India is already in demand. The son of notorious property developer Donald Trump is reported to be planning a USD1bn fund to acquire luxury property in India. The country's finance minister P. Chidambaram said yesterday: "The government has charted out a new path which will end India's nuclear isolation and will pave the way for India becoming an economic superpower." Far-sighted hedge fund managers will no doubt share his view.
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