Hedge funds expected to keep pace with evolving litigation landscape

The financial services industry has faced increasing regulation and oversight during the last few years with no segment of the market able to avoid scrutiny. Hedge funds have traditionally been conservative regarding their responsibilities around shareholder litigation, with many just opting for a simplified claim filing solution in U.S. settled actions. Given the SEC’s 2019 Interpretation Regarding Standard of Conduct for Investment Advisers they may have to re-evaluate that stance.

The SEC has emphasized that an advisor’s fiduciary duty is broad and spans across the entire client relationship beyond merely selecting appropriate investments. When applying this perspective to litigation, there are new developments in the industry that funds should start considering their approach on:

• Increased volume of actions outside of North America that have a significant impact on U.S. investors
• Introduction of Antitrust cases around rate-fixing and market manipulation that result in massive settlements
• Ability to opt-out of class settlements in order to pursue increased recoveries through direct litigation

Not all of these opportunities may be applicable to every portfolio but advisers need to at least be aware they exist in order to properly evaluate their client responsibilities. The SEC has yet to specify exactly what level of depth is required for litigation but their Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers can be a useful guidepost. Proxy voting is certainly different than shareholder litigation, but the recommendations around proper oversight can be extrapolated:

• Development of a written policy and governance procedures to ensure adherence
• Analysis of risks and benefits of different approaches to ensure proper decision-making
• Due diligence on vendor relationships if choosing to outsource to a third-party that specializes in the space

These practices are nothing new to funds but they now have to consider a wider scope as it pertains to shareholder litigation. Advisers would be wise to start establishing proper governance programs because regulation and the complexity of the litigation landscape are only going to increase from here.

Additional Sources:

• Read Hedge Fund Law Report’s article ‘Fund Managers Must Evaluate Their Claims Policies to Avoid Breaching Fiduciary Duty’ (subscription required)