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February 28, 2005 at 07:00 PM
Many money managers are confronted by an unhappy investor at some point–usually after a downturn in performance. Investor claims can have a big effect on your bottom line and your peace of mind, but an attorney experienced with investor claims can help you avoid or, if necessary, defeat such claims.
Our firm consults with hundreds of investment advisers about many aspects of their business, and we have handled a wide variety of investor claims and disputes over the years. We are particularly proud of recently winning an arbitration proceeding that involved a claim for US$50 million. Based on our experience, here are a few practical suggestions on how to protect yourself from a disgruntled investor.
Be Prepared
Don’t be surprised to find that, if you lose money, one or more of your investors will claim to be “shocked” by the losses and insist that they were promised that there was no risk of negative performance. Your best defense against such claims of fraud is your marketing materials and client agreements. Make sure that these documents are up to date and that all material risks are explained and accepted. Also, make sure that you follow any limitations or other descriptions of your investment strategy that are in the materials you give to investors.
Unhappy investors also sometimes complain about “mismanagement.” To defend against such claims, it will be important to show that your interests were aligned with your investors. One of the best ways is to “eat your own cooking” by investing your own money along with your investors (whether in a hedge fund or a separate account). Clients are usually reassured if they learn that you lost money, too, and even if they aren’t, your losses will be undeniable evidence of your good-faith belief in your investment strategy.
Be Cooperative
The first instinct of many money managers when confronted by an angry investor is to want to hit back. That is certainly understandable, but it usually is better to try to be constructive. Most claims begin with an inquiry or request, and many potential claims can be defused by a cooperative answer. Conversely, an investor who feels stonewalled will be much more likely to file a claim. That doesn’t mean that you have to give in to every request, but you should do your best to show your investors that you are not trying to hide anything.
Cooperation is important, because you can suffer serious (and sometimes irreversible) consequences from the mere filing of a claim in court or arbitration. Any such claim may need to be disclosed to existing and potential clients, auditors and insurers (and in some cases, regulatory authorities). Simply having a claim outstanding–no matter how unjustified–will make it much harder to solicit and keep other investors. So it is important to try to resolve any problem before a claim is filed.
Be Patient
Our clients deal with millions of dollars of investment risk, but for anyone it is easy to be disoriented by the risks of litigation. One common pitfall is to be too anxious to resolve any dispute as quickly as possible. Too much urgency can be counter-productive.
Don’t rush. The wheels of justice usually grind slowly, and that may be a good thing if you are faced with an unhappy investor. The conventional wisdom among lawyers is that time tends to favor the defendant. After all, it is the plaintiff who wants to change the status quo–usually by getting the defendant to write a check. And plaintiffs tend to get more reasonable about settling a case when they realize that they will have to spend time and money if they pursue it.
