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When a Hedge Fund Fails

Posted: Sep 04, 2015 | Posted in:

Imagine being responsible for hundreds of millions, or even several billion, dollars of other people’s money. Imagine that you are getting paid more than enough to live a lavish lifestyle in New York City to manage that money – to study diverse markets and make investment decisions to protect it and make it grow. Would you make safe decisions and hedge your bets? Or, would you risk it all and more in the name of padding your own bank account?

In a nutshell, these are the decisions faced by hedge fund managers. When they make the wrong decisions, it can cost numerous people their life savings – and cost the hedge fund manager their careers. This article takes a look at what happens when a hedge fund fails.

What Causes a Hedge Fund to Fail?

With a hedge fund, investors’ assets are pooled into a single fund which the hedge fund’s manager then invests in securities and other investment vehicles. Managers have a number of tools and strategies available at their disposal to enhance their money-making potential. While these can be exceedingly complex (which is why only sophisticated investors should consider investing in hedge funds), some of the more common examples include:

  • Margin and Leverage – When a hedge fund uses margin, it is borrowing money to invest along with its clients’ principal. Investing more money allows for greater returns (this is known as “leverage”); but, the fund also runs the risk of losing the borrowed amount. Excessive leverage can lead to substantial losses above and beyond the value of the fund. The lender can also make a “margin call,” requiring the fund to sell off assets quickly (and often at a steep discount) in order to pay back the debt.
  • Risky Short-Term Investments – Hedge fund managers often make short-term investments based on what they view as opportunities to exploit favorable market conditions. When their assumptions turn out to be incorrect, they can lose extraordinary amounts of money in a very short period of time.

When used properly, these tools can result in significant returns. However, as you can see, they can also lead to disastrous results. Fund managers who knowingly take unreasonable risks can face liability for securities fraud.

A Recent Example

To illustrate the point, let’s look at a hedge fund that failed in early 2015. The Canarsie Capital LLC hedge fund was run by a former Morgan Stanley risk manager and a 28-year-old trader named Owen Li. In March 2014, the fund had grown to $60 million in investor assets and held investments totaling $98 million thanks to leveraged trading. According to one investor, the fund had experienced a 50 percent return in 2013.

After a handful of unsuccessful trades in 2014, Mr. Li undertook trades that he later described as, “a serious of aggressive transactions.” The result of these aggressive transactions? The former $60 million lost all but $200,000 in a matter of about three weeks.

Contact a Securities Fraud Attorney at Zamansky LLC

Zamansky LLC’s attorneys represent clients who have suffered stock market losses in hedge fund failures and other cases that involve securities fraud. We provide experienced, aggressive representation to individuals living in New York and nationwide. To schedule a free consultation, please contact us today.