Once reserved strictly for wealthy, financially sophisticated investors, hedge funds have become increasingly popular investment vehicles for traditional investors. Often, this is achieved through investment in “funds of hedge funds.”
Hedge funds are not SEC regulated.
Both hedge funds and funds of hedge funds have risks that are inappropriate for most investors. Financial advisers may make exaggerated and misleading claims about these funds in order to lure potential investors. Hedge fund managers have also been known to defraud investors.
If you lost money on a hedge fund that you believe was inappropriately recommended, misrepresented, or fraudulently managed, contact the Business Trial Group for a free case review.
How Hedge Funds Work
Hedge funds are a type of investment fund. Like mutual funds, hedge funds pool the money of many investors and follow a specific investment strategy. But that is about as far as the similarities go.
Unlike mutual funds, hedge funds are not regulated by the Securities and Exchange Commission (SEC), and therefore do not offer many of the investor protections that mutual funds and other registered investment products do.
Funds of Hedge Funds
Hedge fund investment is usually limited to wealthy individuals and institutional investors. But funds of hedge funds—an indirect way of investing in hedge funds—typically require lower minimum investments that make them accessible to a broader investor class.
While funds of hedge funds may be registered SEC products, the underlying hedge funds are not. Funds of hedge funds thus carry the same investment risks that hedge funds do.
Hedge Fund Risks
The risks of investing in hedge funds and funds of hedge funds include:
- Not SEC Registered: Because hedge funds are not required to be SEC registered, they are not subject to mandatory reporting rules. As a result, it can be very difficult for investors to gauge a hedge fund’s performance. This can make it easier for a hedge fund manager to commit fraud.
- Speculative Investing: Hedge fund managers are paid based on the fund’s performance, which gives them an incentive to maximize positive performance. This can lead to sophisticated (read: risky) investment strategies such as short selling, derivatives investment, leveraging, and hedging.
- Illiquidity: Hedge fund investors may be unable to recoup their investment money if they want to opt out of the fund.
- Expensive: Hedge funds usually have numerous fee layers and impose higher investor costs than mutual funds.
- Tax Complexity: Hedge funds’ complex tax structure can present delays and difficulties during tax season.
When You May Have a Claim for Hedge Fund Investment Losses
Hedge fund misconduct commonly occurs in the context of how the fund was sold.
Unless you are a wealthy, financially sophisticated investor, a hedge fund is mostly likely an unsuitable investment. And even if you are an accredited investor, an adviser must accurately present important information about the hedge fund. Any misrepresentations or omissions of material facts could constitute misconduct.
Broker misconduct is common in hedge fund sales.
For non-accredited investors, funds of hedge funds may be suitable investments—however, their growth forecasts, risks, and drawbacks must be accurately presented.
Absent any misconduct in the sales stage, hedge fund managers and operators can commit investment fraud. Examples of fraudulent hedge fund conduct include providing phony account statements, not disclosing conflicts of interest, misappropriating investor funds, and operating Ponzi schemes.
Investors with questions or concerns regarding a hedge fund they invested in should speak with a hedge fund fraud lawyer. Receive a free legal consultation from the Business Trial Group.