Hedge Fund Service Professionals Owe No Fiduciary Duty to Investors

In an action arising out of a hedge fund fraud claim, investors sought to recover damages from the fund’s outside professionals including the hedge fund’s legal counsel and auditor. The First Department overturned orders from the court below and dismissed the complaints against the hedge fund’s legal counsel and auditor.

In a combined appeal heard in the First Appellate Division of New York State Court, the plaintiffs (Eurycleia Partners, LP) alleged that Seward & Kissel, LLP (S&K) were liable to the investors for damages because S&K knowingly made false and misleading statements. “They allege that S&K prepared the fund’s offering memorandum, listed itself therein as counsel, and invited prospective investors to rely upon its legal opinions, and that therefore S & K is liable for the statements contained in the memorandum concerning the fund’s investment strategy, which allegedly were false at the time that they were made.”

However, plaintiffs did not allege that S&K made any statements directly to the plaintiffs. The pleadings indicated that the alleged false statements were contained in the offering document. Since the offering document is from the hedge fund to the investors, there were no false statements made by S&K to the investors.S&K never made any material representations to the investors directly. If they had, S&K might have been liable for fraud. The fiduciary analysis comes into play when discussing whether or not S&K omitted material facts which they had knowledge of.

Plaintiff’s alleged that S&K knew that the Hedge Fund had deviated from the strategy described in the offering document and failed to make required filings with the SEC and had not retained TBS (RSM McGladrey) as its auditor.

In order for an omission to constitute fraud, there must be a fiduciary relationship. The court held “[a]s counsel to the fund, not to the investors, S & K’s fiduciary responsibility was to the fund, not to plaintiffs.” Thus, no fiduciary duty existed and S&k has no liability to the plaintiffs.

The decision in this case was based on a motion to dismiss. (For those non-lawyers reading, a motion to dismiss is granted when the plaintiffs fail, at the outset of a case, to state a claim for which relief can be granted. This decision was based purely on the initial pleadings in the case and involves no analysis of the veracity of the underlying facts. When deciding a motion to dismiss, the court gives the plaintiffs the benefit of every possible factual inference.)

This case is different than Stoneridge because Eurycleia Partners involved common law claims, not securities act claims.

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Eurycleia Partners LP et al. v. Seward & Kissell, LLP, et al.

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