The coronavirus chaos spreading through the financial markets is driving some hedge funds and other private funds to shut down.
During this tumultuous time, managers tasked with liquidating funds must nonetheless dutifully conduct value realization due diligence. This note is intended to aid affected managers by providing considerations for the disposition of certain illiquid assets—specifically, the selling of future securities class action (and related legal) recovery claims.
The information may also be useful for funds continuing as a going concern but still have a need for returning outside capital. In any event, selling the rights to legal claims can aid fund managers by providing immediate liquidity while lessening ongoing administrative burdens. Fund stakeholders can likewise benefit by receiving adequate compensation without incurring the downside risk of a prospective claim.
The niche industry of fund closures
Though COVID-19 is causing unprecedented financial woes, veteran hedge fund managers know that fund shutdowns are commonplace. In fact, hedge fund closures notably outpaced launches in 2019. According to industry tracker
Hedge Fund Research, 738 hedge funds closed, while only 480 new funds launched. Because wind-downs have been an integral part of the hedge fund business, a niche industry has developed for assisting managers with value realization at the final stage. Though liquidating publicly traded securities may not require the aid of an advisor, monetizing alternative or illiquid assets may necessitate the assistance of a specialist. In addition, there may be hidden value beyond the assets listed on the fund’s balance sheet. Specifically, an inquiry should be made into whether assets have securities litigation claims of any worth. Before delving into how to make such an assessment, it is useful to first understand how a future securities claim derives its value.
The premise of a securities class action claim
Simplistically, a typical securities fraud class action alleges that (a) an issuer and/or its executives made material false statements that inflated a company’s stock price, (b) certain investors purchased the stock during the period when the price was inflated, (c) an event occurred exposing the fraud and causing the stock price to decline, and (d) under securities laws, investors have a claim for the losses suffered as a result of the fraud. When a securities lawsuit results in a monetary award, impacted investors can make a claim for their respective portion. Therefore, if a hedge fund is in the affected class, it may ultimately receive money for its claim… or it could sell that prospective claim today for real dollars.