The collapse of some hedge funds may be turning into the next cause celebre for plaintiff’s attorneys who file arbitration claims on behalf of investors looking to recoup losses.
And while lawyers are clearly taking aim at giant hedge funds managed by firms such as The Bear Stearns Cos. Inc. of New York, they are also starting to file arbitration claims against smaller funds owned or managed by brokers and advisers.
The claims are being filed with the Financial Industry Regulatory Au-thority Inc. of Washington and New York, and the American Arbitration Association of New York.
With the record number of investor claims filed after the burst of the tech stock bubble and the subsequent collapse of the stock market just about exhausted, the combination of the breakdown of high-profile hedge funds and the collapse of smaller funds in which advisers owned a stake is giving fresh fodder to some plaintiff’s attorneys.
“Of course I expect to see an increase” in arbitration claims involving hedge funds, said a partner with a Beverly Hills, Calif. specializing in representing investors.
And cases involving smaller or more obscure funds are part of the trouble, he said.
Calling his most recent series of claims involving 24 households in San Luis Obispo, Calif., a “cancer cluster. These things are being put together all over the country by promoters and sold through independent-contractor brokers in small communities.”
The number of hedge funds has exploded this decade, said Ryan Tagal, director of hedge funds and alternative investments with research firm Morningstar Inc. in Chicago. That in-cludes both smaller funds, with $5 million to $10 million in assets, as well as big funds with more than $1 billion.
There are 10,000 to 12,000 hedge funds, Mr. Tagal said. He estimated that about 2,000 existed five years ago.
And the marketing of those once ultraexclusive funds has also increased, he said.
Over that time, there’s also been an “explosion of third-party marketers” who specialize in hedge funds, Mr. Tagal said. “They’re individuals with a Wall Street Rolodex. Maybe they come from a trading desk or a prime broker,” he said.
“Hedge funds are a little less country clubbish than five years ago.”
Securities regulators have re-cently made inquiries into hedge funds. Last month, regulators from the office of Massachusetts Secretary of the Commonwealth William F. Galvin said they were investigating two Bear Stearns hedge funds that collapsed this summer and whether the company made improper trades in those funds that saddled investors with additional losses.
Losses at the two mortgage-related funds, the Bear Stearns High-Grade Structured Credit Strategies Fund and High-Grade Structured Enhanced Leverage Fund, cost investors $1.6 billion.
The losses in hedge funds are likely not to be as widespread among retail investors or as damaging to them as the meltdown of technology shares, observers said. Tech stocks were sold directly to retail investors, who also had exposure to them in shares of mutual funds.
Regardless, hedge fund losses are significant, one lawyer said.
The Bear Stearns case “is the tip of the iceberg,” said Steven Caruso, a partner in New York with Maddox Hargett & Caruso PC of Indianapolis.
By the middle of this month, he expects to file a dozen claims against Bear Stearns for investors whose losses ranged from $250,000 to $1 million, he said.
But cases involving smaller funds and companies are popping up, lawyers said.
Last month, Andrew Stoltmann, a lawyer in Chicago, filed his first arbitration claim for four investors, involving a hedge fund that one client estimated had assets under management of $50 million. “I’d never seen a hedge fund case until six months ago,” he said.
Two former brokers with UBS Financial Services Inc. of New York, Matthew Sample and J. David Cross, left the company last year, became registered investment advisers and set up their own hedge fund.
Through their firm, Sample & Cross Capital Management LLC of Lake Forest, Ill., they ran the Vega Opportunity Fund LLC.
The Vega fund was sold as a “safe hedge fund to invest in,” according to Mr. Stoltmann’s claim, which alleges losses of $475,000 and claims that the advisers committed fraud by misrepresenting the risk in the fund.
In one day in August, the fund lost more than 75% of its value.
“This is about the retailization of hedge funds,” Mr. Stoltmann said, alleging that the rule requiring an investor to have a net worth of $1.5 million was ignored. “It’s a hedge fund, but the $1 million limit did not apply.”
Clients allegedly had losses of $14.6 million. Jeffrey Forrest, the broker who was affiliated with Associated Securities Corp. of El Segundo, Calif., began to sell his clients the APEX Equity Options Fund LP in 2005, according to one of the statements of claim. The fund was valued at more than $46 million.
Pacific Life Insurance Co. of Newport Beach, Calif., owned Associated until this year, when it sold it to Linsco/Private Ledger Corp. of San Diego and Boston.
“As is customary in transactions of this type, Pacific Life has agreed to indemnify LPL for certain liabilities related to pre-close activities,” Tennyson Oyler, a company spokesman, said in a statement.
Mr. Forrest told clients that the investment in the APEX system or process would protect their principal, the claim stated, and that the investment was liquid at all times.
In August, the fund’s management told investors it was hit with a near-total loss, according to a published report.
Thomas Ajamie, a lawyer in Houston, last year filed a case against Morgan Stanley of New York and one of its brokers, claiming that the broker in 2001 invested $2.5 million for a retirement plan of a small company but failed to disclose that the broker received a 25% share of the fund’s profit.
Mr. Ajamie’s client, Pipe Distributors Inc. of Houston, Texas, wound up losing $725,000.
With so many hedge fund products on the market, Mr. Ajamie is curious as to how many registered representatives had a piece of the action during the hedge fund boom.
“How many brokers were out there setting up their own hedge funds?” he asked.