Hedge Fund Ruling Ignites Broker Duty Debate In Bermuda

Royal Gazette

25 April 2001

This story was reproduced by kind permission of the Bermuda Royal Gazette at: http://www.accessbda.bm

A US federal court ruling has re-ignited debate on the duties of a broker in relation to monitoring fraudulent activities of a hedge fund.

The case was one brought by former investors in Bermuda-registered Manhattan Capital Management hedge fund, which went down over a year ago.

The fund was falsely reporting investment gains while it was actually losing money. It ultimately cost investors over $400 million.

In a class action lawsuit against Bear Stearns, the US investment bank, the investors claimed Bear Stearns was partly responsible for the fraud because it was aware of the losses and yet continued to extend money to the fund to enable it to continue trading. They also accused the bank of using this information to tip off certain investors so that they could withdraw money without suffering losses.

But the judge dismissed the case on Wednesday, ruling, "While the ponzi (pyramid) scheme may only have been possible because of Bear Stearns' actions, or inactions, Bear Stearns' conduct was not the proximate cause of the ponzi scheme".

This ruling was a setback for those who argued that clearing firms, such as Bear Stearns, should be held liable for the intimate knowledge they possess of the companies they clear trades and lend money to. There was also surprise at the ruling because the bank had not denied, in the proceedings, that it had been aware of the fraud.

Bear Stearns originally tried to appear the hero of the piece by saying it had alerted the Securities and Exchange Commission to the fund after investors had raised questions. However the SEC provided testimony that the bank had become suspicious about the fund about a year before its collapse and had contacted the Bermuda regulators.

Daniel Kramer, lawyer for Bear Stearns, said, "It (the ruling) is a very important decision for clearing firms. The decision re-affirms the principle that clearing firms will not be held liable for aiding and abetting fraud or breach of fiduciary duty merely because they provided margin and clearing services to their customers."

Recommended