Hedge Funds Holding Up Investors Face Involuntary Bankruptcy

Date: Tuesday, February 19, 2008
Author: Andrew Harris, Bloomberg

Ritchie Capital Management LLC, the operator of four hedge funds that failed since 2006, is fighting what may be an unprecedented bid by investors to recover their money by forcing one of the funds into bankruptcy.

If the effort succeeds, Ritchie may have to open its records to an extent rarely seen in the secret world of hedge funds. The scrutiny might reveal trading strategies, expose managers to lawsuits over losses and inspire investors in other funds to follow suit.

``Hedge funds aren't like public companies subject to disclosure,'' said Jay Westbrook, a University of Texas bankruptcy law professor. ``They operate in the dark, and they like it there.''

While hundreds of hedge funds fail regularly, Ritchie lawyer Ronald Barliant said involuntary bankruptcy is almost unheard-of.

``I don't know of any other cases like this one,'' said Barliant, 62, a bankruptcy judge for more than 14 years who's now a partner at the Chicago law firm Goldberg Kohn.

Attorneys for the Ritchie Multi-Strategy Global fund asked a judge in January to throw out an involuntary-bankruptcy petition filed by three investment companies seeking to recoup more than $45 million of roughly $1 billion for which they say Ritchie is liable. The Lisle, Illinois-based parent company has been winding down Multi-Strategy's business for two years.

Investors demanded balance sheets for every entity Ritchie Capital Management owned in April 2007, when they say it sold most of its Multi-Strategy fund assets for $285 million.

Clashing Claims

The petitioners claim they want to ensure Ritchie Capital Management got top dollar. Ritchie's attorneys say the investors knew the fund's risks and shouldn't be using bankruptcy as a tool for prying into company business.

Ritchie Capital Management was founded in 1997 by Thane Ritchie, its chief executive officer. The firm manages more than $1 billion in investor assets including the remnants of Multi- Strategy, spokesman Justin Meise said in a telephone interview.

The petitioning investors are two funds managed by Tacoma, Washington-based Benchmark Plus Management LLC and the Sterling Low Volatility Fund QP, a unit of Cleveland-based National City Corp. Ritchie has more than 90 investors, its lawyers said.

The three petitioners say payment demands were denied, making them ``creditors'' with standing to push the fund into bankruptcy.

After receiving a partial payment in 2007, investors were told they would get the rest of their money in annual installments over three years, according to their court papers.

Investor Suspicions

The petitioners say Ritchie may have wrongly put its own interests ahead of theirs because the company was hired by the buyer to manage the Multi-Strategy assets it sold.

Ritchie Capital Management says investors knew of ``substantial risk that the fund's investments would not turn out well and that they might lose their entire investment.''

``The fact that somebody wants information is not a reason for the entity to be in bankruptcy,'' said Barliant, the Ritchie lawyer. ``In my view, it's not an appropriate strategy for anyone to pursue if what they want is information.''

With the fund failing, the investors decided ``a bird in the hand was worth taking'' and approved the asset sale to New York-based Reservoir Capital Group, their attorney Jeff Marwil, 46, of Chicago-based Winston & Strawn, said in an interview.

``The investors lost confidence in the credibility and integrity of this manager,'' Marwil said.

Hedge funds are loosely regulated investment pools, generally open only to wealthy people and institutions. U.S. law exempts from regulation individuals with more than $5 million and institutions with more than $25 million in invested capital.

Flawed Definitions

An appeals court in 2006 struck down an SEC attempt to compel hedge fund managers to register. The agency's definition of ``hedge fund'' and ``client'' were deemed flawed.

Investors are increasingly turning to regulation by lawsuit, said attorney Barry Barbash, a former director of the SEC's Investment Management Division. Where hedge funds are concerned, the SEC is limited to responding to accusations of investment-adviser fraud, he said.

``You're not going to have the SEC generally examine the books and records of hedge fund managers,'' said Barbash, of New York's Willkie Farr & Gallagher.

``By virtue of being in bankruptcy, you have an ability to get chapter and verse from the debtor on everything,'' said Douglas Baird, a University of Chicago law professor. ``The debtor has to show up and fess up.''

One alleged misdeed that might be found is preferential treatment of investors, said the University of Texas's Westbrook.

Unequal Treatment

``Some people might get paid and others not get paid,'' he said. ``Some people might have been given the opportunity to buy out when others weren't.''

Ritchie asked U.S. Bankruptcy Judge Susan Pierson Sonderby in Chicago to throw out case, arguing that the investors are equity owners, not creditors.

The company, after submitting final papers due today, will return to court Feb. 26, when Sonderby may hear arguments.

An investors' victory would be ``a wake-up call for the entire hedge fund industry,'' Barbash said. It would also be a warning to fund managers to increase their investment diligence to avoid undue risk, he said.

``It might be a case that it'll keep the fringe players out of the business, because they'll know there's a potential to get really hammered,'' Barbash said.

The case is In Re: Ritchie Multi-Strategy Global LLC, 07- 24236, U.S. Bankruptcy Court, Northern District of Illinois (Chicago).

To contact the reporter on this story: Andrew Harris at the U.S. courthouse in Chicago at aharrisl6@bloomberg.net .