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Thursday, October 05, 2006

The Amaranth Hedge Fund and Legal Strategies for Its Investors

The meteoric rise and fall of the Amaranth Hedge Fund is a clear warning for investors: know your hedge fund.

Amaranth recently lost $6 billion of the $9 billion which investors poured into the fund. Most of the blame has been placed on a purported "rogue" 32 year old energy trader named Brian Hunter. Earlier in the year, Hunter made $2 billion for the fund trading natural gas but his enormous gains quickly turned to stunning losses when the market reversed.

The message of the Amaranth Hedge Fund debacle for investors is simple - be familiar with the type of investments in which your hedge fund is investing. If a hedge fund such as Amaranth bills itself as a "multi-strategy" fund but, instead, it invests heavily in a single strategy such as natural gas, it may be time for investors to head to the exit. This type of shift is called "style drift" in which the hedge fund drifts from its initial strategy which it promised to investors into some other and likely more risky strategy which was never disclosed to investors.

Investors, whether they are high net worth individuals or pension funds, are entitled to rely on representations made at the time of investment by the hedge fund as to the nature of the fund's investment portfolio. If the style or investments "drift", the hedge fund may have breached its fiduciary duty to investors and may be liable for misrepresenting the nature of the strategy employed.

"Style drift" is likely to be legal basis upon which investors sue their hedge funds for fraud and misrepresentation.

Another potential target of investor claims will be the "prime brokers" who often allow hedge funds to dramatically increase their risk by providing them with virtually unlimited leverage or margin with which to trade. The gains can be exponentially higher, but the risk to an unknowing investor may be more than is tolerable for their portfolio.

Investors are also entitled to proper supervision of hedge fund traders by hedge fund managers. To the extent that the manager-supervisor abdicated their responsibility, they may also have personal liability for the collapse of hedge funds.


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