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Registered Hedge Fund Suit Raises Key Issues


An amended lawsuit just filed against a UBS Paine Webber/Mark Advisors hedge fund could bring to light some of the biggest challenges faced by the growing number of firms sponsoring SEC-registered hedge funds. The suit challenges earnings and investment representations, and raises questions about how these funds are explained to brokers and marketed to investors.

SEC-registered hedge funds have been flooding the securities market as sponsors hope to lure wealthy investors with alternative investment products that produce positive absolute returns not correlated with the stock market. In many cases, sponsors are hiring traditional hedge fund managers to manage all or a portion of the fund's assets.

But sponsors, and investors, beware! A hedge fund manager's successful past performance record doesn't necessarily mean he'll repeat that stellar performance in current markets.

The PW Aspen Fund, a closed-end limited liability private investment company, has been named among the defendants in an amended lawsuit filed in the U.S. District Court for the Southern District of Florida. The lawsuit, originally filed last August, charges that before its initial offering in November 1999, the fund misrepresented how the assets would be invested. The suit also charges that a $2 million investment which was to have been made into this fund by the fund's sub-advisor was never made.

The fund is managed by PW Aspen Management, a joint venture between PW Fund Advisors of New York, the alternative investments management group of UBS Paine Webber, and Mark Advisors, also of New York. All three firms have been named defendants in this lawsuit, which could be granted class action status by the court.

Paine Webber launched a flurry of similar registered hedge funds in 1999 and 2000, many of which carried tree names (willow, birch, juniper, redwood, sequoia) and some of which had single or multiple managers.

Morris Mark has served as the president, and treasurer of Mark Advisors, as well as Mark Asset Management an affiliated investment firm. He also manages traditional hedge funds, including Mark Partners and Mark International Partners, according to SEC filings.

The lawsuit, which was filed on behalf of at least two investors by the Miami law firm of Payton & Carlson, charges that investors were told that the fund would "invest conservatively and preserve capital under various market conditions by making substantial use of what is known as hedging' and by employing broad diversification in portfolio selection."

According to marketing materials that were allegedly distributed to about 50 of Paine Webber's largest-producing brokers, Mark Advisors was to employ similar investment strategies for this fund as its hedge funds. That strategy, brokers were told, included hedging between 10% and 30% of the fund's securities to preserve investors' capital, according to the suit.

But in reality, when it came to managing the PW Aspen Fund, the sub-advisor hedged only a tiny fraction of the assets, the suit charges. Moreover, investors were never told that the fund's sub-advisor had apparently changed his investment style to no longer embrace hedging techniques. That exposure to the equity market led to the fund losing more than 70% of its value, and caused the fund's estimated 500 investors to suffer a collective $162 million loss, according to the suit.

One investor, an East Coast lawyer who spoke to Mutual Fund Market News on condition of anonymity, said executives from Paine Webber continually referred to the fund as a "hedge fund."

Furthermore, these Paine Webber executives provided repeated assurances that as the fund's advisor they would intercede and/or remove the fund's assets from the manager's control if they saw the fund's performance decline, the former investor said. In addition, he said he was repeatedly talked out of liquidating his investment until he had seen his original $500,000 investment drop by 65%.

Furthermore, the lawsuit claims that instead of achieving broad diversification across various industries and not investing more than 25% of the fund's assets in any one industry, the fund was heavily concentrated in media companies and related industries.

According to the plaintiffs' attorney, Curtis Carlson, between 25% and 31% of the fund's portfolio was invested in cable media companies throughout the period June of 2000 to December 2001.

"Paine Webber touted this product to investors as an investment that would provide safety in either an up market or a down market," Carlson said. "Investors were told they were getting into a Volvo, and what they were sold was a Ford Explorer with Firestone tires."

UBS Paine Webber declined to comment on the specifics of this lawsuit. But a company spokesperson said. "We intend to vigorously defend the case."

Neil Koslowe, an attorney with Sherman & Sterling of Washington, which represents Mark Advisors, noted that this lawsuit had once before been dismissed by the court. "The suit, in our view, has absolutely no merit," he added.