Legal News

2nd Circuit Decision May Be Harbinger For Madoff Feeder Fund Suits

By Amir Efrati

In the wake of the Bernard Madoff scandal, lawsuits have flown left and right as victims search for deep pockets. Among the targets: so-called feeder funds that channeled client money to Madoff — J. Ezra Merkin, Fairfield Greenwich Group and Tremont, among many others — but it remains to be seen how they will fair. (For an interesting flow chart showing how dozens of feeder funds put client money at Madoff’s firm, click here.)

Today, AmLaw Litigation Daily bring us news of a ruling that could aid the defense of certain feeder funds that were sued.

Remember Sam Israel? (LB coverage here and here.) He’s the hedge fund manager convicted of a huge Ponzi scheme fraud. Like Madoff, he depended in part on feeder funds and other investment advisors to channel money to his firm, Bayou.

One of those investment advisors, Hennessee Group, which was supposed to scrutinize and evaluate hedge funds for its clients, recommended to one client, called South Cherry Street LLC, that it invest $1.15 million with Israel’s firm.

When the frauds of Israel and others were exposed, South Cherry filed suit against Hennessee in the Southern District of New York for securities fraud and breach of contract for allegedly failing to perform due diligence.

The district judge dismissed the suit and Cherry Street appealed to the 2nd Circuit court of appeals, where oral arguments were heard on Jan. 16.

In a case decided this week, the 2nd Circuit said an adviser on investing in hedge funds cannot be sued for securities fraud for recommending a fund that later turned out to be a Ponzi scheme. The circuit found that South Cherry couldn’t prove “scienter” (intent or knowledge of wrongdoing) against Hennessee.

Full post as published by Law Blog - WSJ.com on July 17, 2009 (boomark / email).