Contributed by Leslie M. Kelleher, Caplin & Drysdale
Well-publicized fraud scandals, including Bernie Madoff’s $20-billion Ponzi scheme and the Bayou Capital case, to mention only a few, have led to increased regulation of hedge funds.1 But hedge funds are more likely to have been the victims than the perpetrators of fraudulent schemes. Indeed, some of the largest creditors in the Madoff bankruptcy are hedge funds.2
When a hedge fund is the victim of a fraud or misrepresentation, the fund manager is responsible for commencing any appropriate litigation to recover the fund’s losses. It has become commonplace in recent years for the manager to sue in a representative capacity, naming itself as the plaintiff. But unless the fund has assigned its claims, the manager will not have standing. In a recent decision, MVP Asset Management (USA) LLC v. Vestbirk, the Eastern District of California dismissed a securities fraud action by hedge fund manager MVP Asset Management (USA) LLC (MVPAM) for lack of standing.3 The court adopted the reasoning of a 2008 Second Circuit decision holding that, absent a valid assignment of the claim, an investment adviser could not sue for a client’s losses, as the client, and not the adviser, had suffered the actual injury. See W.R. Huff Asset Management Co., LLC v. Deloitte & Touche LLP, 549 F.3d 100 (2d Cir. 2008). MVPAM amended the complaint, alleging that the fund had assigned its claims to the plaintiff manager, but the amended complaint was dismissed on the grounds that the allegations were not sufficient to establish the assignment.4 The court subsequently found that a Second Amendment Complaint was also insufficient to establish the validity of the alleged assignment,5 forcing MVPAM to amend its complaint yet again.
Counsel to hedge funds and their managers should take heed to ensure that the proper party is the named plaintiff in any litigation on behalf of funds. They also should consider revising the contracts with their funds to provide for the assignment of a fund’s claims for collection to the fund’s manager, so that it can sue in its own name. Unless the fund’s claims have been validly assigned to the manager, the hedge fund itself, rather than its general partner or manager, should be the named plaintiff in any securities fraud or similar action to recover losses suffered by the fund.
THE SECOND CIRCUIT’S HUFF DECISION
While there are few cases specifically speaking to the standing of hedge fund managers to sue for their funds, several courts have addressed whether an “investment adviser” has standing to sue under federal securities laws on behalf of its clients, most often in the context of determining whether to appoint the investment adviser as lead plaintiff in a class action suit.6 Until the Second Circuit’s 2008 decision in Huff, the majority view was that an investment adviser had standing to sue on behalf of its client if it had unrestricted investment decision-making authority and had been granted authority to sue as the attorney-in-fact for its client.7 Most of the courts that considered the issue focused solely on the statutory standing requirements, concluding that an investment adviser was an actual “purchaser” of securities and thus had standing to sue under the securities laws.8
It is not enough to establish standing under the securities laws; Article III of the constitution requires also that a plaintiff establish that there is a “case or controversy” before the court by demonstrating the “irreducible constitutional minimum” requirements for standing—injury-in-fact, causation, and redressability.9 See Lujan v. Defenders of Wildlife, 504 U.S. 555, 560-61 (1992). In addition, the Supreme Court has crafted prudential limitations on standing, one of which is that a party “generally must assert his own legal rights and interests” rather than the rights of third parties. Warth v. Seldin, 422 U.S. 490, 499 (1975). While not constitutionally mandated, the prudential rule against asserting third party rights is closely related to “the policies reflected in the Art. III requirement of actual or threatened injury amenable to judicial remedy,” and reinforces constitutional themes. Valley Forge Christian Coll. v. Americans United for Separation of Church & State, Inc., 454 U.S. 464, 475 (1982). The rule “fosters judicial restraint,” assures concrete presentation of the issues and helps courts “avoid ruling on abstract grievances.” Amato v. Wilentz, 952 F.2d 742, 748 (3d Cir. 1991).
The rule against third-party standing is not absolute; a plaintiff may be permitted to assert another’s rights when the plaintiff has demonstrated (1) a close relationship to the injured party, and (2) a barrier to that party’s ability to protect its own interests. See Kowalski v. Tesmer, 543 U.S. 125, 130 (2004). Historically, for example, trustees have been accorded standing to bring suits to benefit their trusts, guardians ad litem to bring suits to benefit their wards, receivers to bring suit to benefit their receiverships, assignees in bankruptcy to bring suit to benefit bankrupt estates, and executors to bring suit to benefit testator estates. See Sprint Commc’n Co., L.P. v. APCC Serv., Inc., 554 U.S. 269, 287-288 (2008).10
Before the decision in Huff, most courts considering the standing of investment advisers to sue on behalf of their clients did not even consider the prudential limitations on third-party standing. In Miller v. Dyadic International, Inc., one of the few decisions to squarely address the issue, the court found that the plaintiff investment adviser had alleged it personally had suffered an injury, as it had a “‘significant financial interest in attempting to recover [its clients' losses] in order to maintain their goodwill and future business,” and a loss in the value of the clients’ portfolios would result in reduced performance-based compensation. No. 07-CV-80948, 2008 BL 85807 (S.D. Fla. Apr. 18, 2008) (alteration in original). But those injuries to the investment adviser were not the injuries alleged in the complaint, and should not have been found to support third-party standing to assert claims for injuries suffered by the adviser’s clients.11 Before the decision in Huff, there was only one reported decision, In re Tyco International Ltd. Multidistrict Litig., 236 F.R.D. 62 (D.N.H. 2006), holding that an investment adviser seeking to recover its clients’ losses had not suffered an injury-in-fact, but, rather, was asserting claims on behalf of another party, and thus had no standing under Article III.
In the Huff case, the district court below had concluded that a grant of a power of attorney authorizing the investment adviser to act as attorney-in-fact for its clients was equivalent to an assignment of the clients’ claims, and thus was sufficient to satisfy constitutional standing requirements—an analysis that conflated the constitutional “injury-in-fact” requirement for a case or controversy with the prudential limits on third-party standing. In re Adelphia Commc’ns Corp. Sec. and Derivatives Litig., No. 03-MD-1529, 2005 BL 70068 (S.D.N.Y. May 27, 2005). The Second Circuit reversed, finding that the adviser did not have standing to assert its client’s rights.
Like the court below, the Second Circuit conflated the constitutional injury-in-fact requirement with the prudential requirement that a party must assert its own rights: as a general rule, the court stated, the injury-in-fact requirement means that a plaintiff must personally have suffered an injury. See Huff, 549 F. 3d at 107. The Second Circuit further noted that an assignment of legal title or ownership of the claims would allow the assignee to stand in place of the injured party and assert the “injury-in-fact” suffered by the assignor. Id., citing Vt. Agency of Natural Res. v. United States ex rel. Stevens, 529 U.S. 765, 773 (2000). Moreover, the Supreme Court has held that the assignee will have standing to pursue the claim even if it has agreed to remit all proceeds of the litigation to the assignor. See Huff, 549 F. 3d at 108, citing Sprint Commc’ns Co., L.P. v. APCC Servs., Inc., 554 U.S. 269, 285-290 (2008). However, the Second Circuit found that Huff’s power-of-attorney did not confer standing because it did not transfer ownership of the claim, but instead merely authorized Huff to act as an agent or attorney-in-fact to conduct litigation on behalf of its clients. The Second Circuit also found that Huff was not in the kind of close relationship with its clients that would qualify for what the court referred to as a “prudential exception” to the rule against asserting third-party standing. Finally, the Second Circuit also rejected Huff’s argument that it had suffered its own “informational injury” when it relied on untruthful information provided by the defendants, as well as injury to its reputation as an investment adviser, and that those injuries were sufficient to establish Huff’s standing. Even if these were cognizable injuries, the court held, they were not the injuries alleged in the complaint, and would not be redressed by the requested money damages for losses suffered by Huff’s clients. See Huff at 110-11.
THE MVPAM CASE
In MVP Asset Management,12 the Eastern District of California followed Huff, and dismissed for lack of standing a claim by a hedge fund manager to recover losses for its fund.
MVPAM, a Delaware limited liability company, is the investment manager to the MVP Fund of Funds, Ltd, a British Virgin Islands investment company (MVP Fund). According to the complaint, MVPAM’s management contract with the MVP Fund granted MVPAM “unrestricted decision making authority to control, and act as MVP Fund’s attorney-in-fact with respect to, all investments and litigation relating thereto.” Like the Huff contract, it did not assign MVP Fund’s investment-related claims to MVPAM.
MVPAM caused MVP Fund to invest $2 million in Ark Discovery Fund (Offshore) Ltd. (Ark Discovery Fund), which was expected to generate high returns by financing the purchase of “white goods” (e.g., household appliances and consumer electronics) by investment-grade “big box” retailers such as Costco and WalMart. According to the complaint, Ark Royal Asset Management Ltd. (Ark) made oral and written misrepresentations to MVPAM that the Ark Discovery Fund was an extremely safe investment that was insured, had a low risk of fraud, and was subject to stringent safeguards by Ark. Rather than a safe investment, however, the Ark Discovery Fund proved to be part of a massive Ponzi scheme run by Tom Petters, head of Petters Group Worldwide which, at one point, included among its extensive holdings Polaroid, Fingerhut, and Sun Country Airlines. Petters was charged criminally in September 2008, the Ark Discovery Fund was liquidated shortly thereafter, and MVP Fund lost its entire investment. MVPAM sued Ark and several associated entities and individuals for securities fraud and other claims. Petters was subsequently found guilty on 20 counts of conspiracy, mail, and wire fraud and, in April 2010, was sentenced to 50 years in prison for his part in the fraud.13
The defendants moved to dismiss the complaint, arguing, among other things, that MVPAM was merely the investment adviser to the MVP Fund, that it had not alleged that it suffered an injury-in-fact, and that it therefore lacked standing under Article III. In response, MVPAM submitted a declaration from MVP Fund’s sole shareholder, stating that MVPAM had used a power of attorney granted to it by MVP Fund to cause MVP Fund to assign its claims to MVPAM before the suit was commenced. The complaint itself did not mention this purported assignment, but instead alleged only that MVPAM had investment making discretion and was the attorney-in-fact for MVP Fund. Because the defendants made a facial challenge to standing, rather than a factual challenge to the substantive allegations of the complaint, the court refused to consider the declaration or any other materials outside the four corners of the complaint.14 MVPAM argued that the allegations of the complaint were sufficient, as the power of attorney was the “functional equivalent” of an assignment of MVP Fund’s claim. The Second Circuit in Huff, MVPAM argued, was wrong to have held otherwise in that case, and the decision should not be followed.
The court disagreed and, adopting the reasoning in Huff, held that “MVPAM’s ‘status as both attorney-in-fact for litigation purposes and an investment adviser with unfettered discretion over its client[’s] investment decisions does not confer on [MVPAM] Article III standing to sue in a representative capacity on its client[’s] behalf.’”15MVPAM was given leave to file an amended complaint.
Where the wrong party has been named as plaintiff, Rule 17(c) of the Federal Rules of Civil Procedure permits a substitution of parties. In the MVPAM case, however, MVPAM already had submitted a declaration stating that MVP Fund had assigned its claims and, presumably for that reason, did not move to substitute MVP Fund as the real party in interest.16 Instead, MVPAM amended the complaint to allege that as attorney-in-fact, it had caused MVP Fund to assign its claim to MVPAM for collection, in exchange for MVPAM’s agreement to account for any funds recovered. According to the amended complaint, this assignment was approved by MVP Fund’s sole voting shareholder.
The defendants sought dismissal again, arguing, inter alia, that MVPAM had not met its burden of adequately alleging that the claim was assigned.17 The alleged power of attorney did not give MVPAM authority to assign MVP Fund’s claims to itself, the defendants argued, and thus the assignment was not valid. The defendants also argued that only MVP Fund’s board of directors, and not the shareholder, could permit such an assignment.18
The court agreed. On September 22, the court dismissed the amended complaint, finding that MVPAM had failed to allege a valid assignment, as only the board, and not the shareholder, could confirm the assignment. MVPAM filed a second amended complaint, alleging that, MVPAM used its general power of attorney to cause MVP to assign its claims to MVPAM. The complaint also alleged that, on May 27, 2011, MVP Fund’s board ratified the assignment of the Fund’s claims to MVPAM.19
The court dismissed the complaint again, on the ground that the bare allegation that “‘MVPAM . . . caused MVP to enter into an agreement with MVPAM under which MVP assigned its claims  to MVPAM for collection’ is insufficient to determine whether a valid assignment has been made.20 The court did not rule on whether the alleged ratification of the assignment was valid. MVPAM has filed a Third Amended Complaint alleging that before MVPAM caused MVP to execute a written assignment of its claims, MVP entered into a non-written agreement assigning its claims to MVPAM, and that the assignment was made in California, which does not require that assignments be in writing.
Given their success in the past, it can be expected that the defendants will once again move to dismiss the complaint. In addition to the validity of the “unwritten assignment,” the court may also be asked to rule on whether the retroactive approval of the assignment will suffice to confer standing on MVPAM, an issue on which courts are split. While some courts (mostly in patent cases) have held that nunc pro tunc assignments cannot confer retroactive standing,21 other courts have held that a post-filing assignment is effective to confer standing on the assignee.22
The latter view is preferred. Where the wrong party is named as a plaintiff, Rule 17(a) provides that the action should not be dismissed “until, after an objection, a reasonable time has been allowed for the real party in interest to ratify, join, or be substituted into the action.” The rule also provides that any such ratification, joinder, or substitution relates back to the time the action was originally filed.23 In the MVPAM case, the claims have been assigned to the fund manager, MVPAM, which is now the “real party in interest” with respect to those claims.24And because MVPAM already is a party to the action, a formal substitution under Rule 17 is unnecessary—MVPAM would be substituted in for itself.25
Any argument that a plaintiff cannot rely on a post-filing assignment to establish standing because it did not have standing at the time the lawsuit was commenced necessarily implies that substitution of the real party in interest under Rule 17 is impermissible, as the original plaintiff would not have had standing when the suit was filed. But the underlying premise—that Article III requires in every case that the plaintiff have personally suffered the injury complained of—is incorrect. Article III requires only that a “case or controversy” exists, and, as the Supreme Court recently emphasized, a “personal stake” is not always required.26 Rather, the “personal stake” requirement is a prudential, rather than a constitutional requirement. It is simply a mechanism to ensure that the “case or controversy” requirement of Article III is met; a “description of the . . . judicial effort to ensure, in every case or controversy, that concrete adverseness which sharpens the presentation of issues . . . .” Sprint, 128 S.Ct. at 2543.27 Thus, for example, the necessary concrete adverseness exists—and Article III requirements are met—when a trustee sues to recover for the trust, or a guardian ad litem for its ward, even though the trustee or guardian has not personally suffered the injury, because “the trustees, guardian ad litem, and the like have some sort of ‘obligation’ to the parties whose interests they vindicate through litigation.” Sprint, 128 S.Ct. at 2543; see also Huff, at 109-10. In promulgating Rule 17, the Supreme Court has recognized that the “concrete adverseness” necessary to meet the case-or-controversy requirement exists when, as in this case, it is apparent that an injury in fact has been alleged, but the wrong party was named as the plaintiff by mistake.28
In the MVPAM case, the question then would be whether “an honest mistake” was made when MVPAM was named as the plaintiff. See Advisory Committee Note to Fed. R. Civ. P. 17. Before the Huff decision, it was generally understood that an investment adviser could file a claim on behalf of its clients as long as it had discretion to make investment decisions and authority to sue. Were the case pending in the Second Circuit, it would be difficult for MVPAM to argue that, post-Huff, it still considered itself the proper party to sue. But the MVPAM case is pending in the Ninth Circuit, and the court made new law in that circuit by following Huff.
The court in MVPAM may not take the draconian measure of dismissing the action—which, it appears, is now time-barred—with prejudice. Indeed, the court appears reluctant to do so, and has allowed MVPAM a third chance to remedy the deficiencies in its complaint. But even if the action is allowed to proceed, the costs and delay to the case while the parties and the court grapple with complicated issues of standing already have been considerable. Such costs can easily be avoided in future cases. Hedge fund managers should consider whether it is in the best interests of their funds for such cases to be commenced in the manager’s name. For example, the manager may want to ensure it can maintain control of any class action lawsuits in which its funds are plaintiffs, and thus prefer to sue in its own name so that the funds’ aggregate losses will be considered in a motion to be appointed lead plaintiff. And funds may have business reasons to prefer not to be named as plaintiffs. If so, managers should consider revising their agreements with their funds to provide a clear assignment of any claims the funds may have in connection with fund investments.29 The fund may assign its claims on a case-by-case basis as well. If it does so, counsel would be well-advised to document any such assignment, adhering to corporate formalities, to avoid any question of validity. In the absence of an assignment, any suit to recover losses suffered by the fund must be commenced in the name of the fund itself, rather than the manager.
Leslie M. Kelleher is a member in Caplin & Drysdale’s Washington, D.C. office. She joined the firm’s litigation group in 2005. Her main areas of practice are complex litigation and creditors’ rights. Before joining the firm, Ms. Kelleher was a professor of law at the University of Richmond Law School, where she taught civil procedure and federal courts, as well as corporations, and mergers and acquisitions. She has published several articles in those areas. After graduating from law school in Canada, Ms. Kelleher clerked for the Honourable Mr. Justice Le Dain of the Supreme Court of Canada. She then obtained an LL.M. from Columbia Law School, and practiced for several years in New York, with an emphasis on securities litigation.
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