Litigation is becoming more and more a part of the everyday world of hedge funds. Funds are finding themselves in courtrooms in any number of different roles.
Hedge funds have increasingly turned to lawsuits as tools with which to influence the management of the companies in which they have invested. One newsworthy example of this is the high-profile InfoUSA lawsuit. InfoUSA’s founder, Vin Gupta, is accused of corporate waste on a scale of millions of dollars. He is accused of using company funds and assets to curry favor with Bill and Hilary Clinton (in the form of flights on the corporate jet and other items), as well as paying for an 80-foot yacht and condos in Hawaii and California with company money. Hedge fund Dolphin Limited Partnership brought the lawsuit along with investment manager Cardinal Value Equity Partners.
The lawsuit was brought in the form of a shareholder derivative action. This is a type of lawsuit that any shareholder can bring, but few do because of the costs. A shareholder derivative action is brought against officers and/or directors of a corporation (the “defendants”) on behalf of the corporation itself, when the directors won’t take action to enforce the company’s rights. This type of lawsuit challenges decisions that officers and directors have made, where a shareholder claims that the decisions were not in the best interests of the corporation and have harmed the corporation (in most jurisdictions, a member of an LLC can also bring a derivative action). Derivative complaints commonly include claims that the people who manage the company have engaged in corporate waste, self-dealing, and breaches of their fiduciary duties.
The interesting thing about derivative actions is that a successful shareholder does not recover money directly. Any judgment in the case is entered in favor of the corporation. A shareholder may benefit indirectly, of course, by enriching the corporation at the expense of the officers or directors, but the more direct result of this type of lawsuit is that the shareholder is exerting influence on the company’s management. A derivative suit is a big stick that investors such as hedge funds may be able to use to ensure that management toes the line and acts in the best interests of shareholders.