Madoff case highlights PE liability risk

PPMs that don’t contain explicit risk disclosures are vulnerable to LP lawsuits, warn lawyers reviewing a case connected to the Madoff scandal.

Fund documents and marketing material that provide firm-specific risks to investors and specifically outline what duties the advisor will take when making investments is the best safeguard against a rise in LP litigation, stress industry legal sources.

The importance of PPMs, partnership agreements and other documents that go above and beyond standard boilerplate language was brought to the fore in recent US court case Wexler v. KPMG, which cleared a private fund advisor’s name for alleged fraud, breach of fiduciary duty and professional negligence.

An investor claimed they became an indirect victim of Bernard Madoff's ponzi scheme by being misled into a feeder fund advised by Tremont Partners.

The plaintiff said language in the fund’s private placement memorandum (PPM) was unclear about how Tremont would evaluate potential underlying managers. But the court disagreed, ruling that the PPM outlined fund-specific risks associated with its investment strategy, including specific enough language that spelled out the fund manager’s duties when choosing third party managers.

The case means funds should carefully review what types of specific disclosures are being written into fund agreements and marketing material, said Stephen LaRose, litigation partner at law firm Nixon Peabody. “We are seeing more investor litigation, probably caused by the financial crisis which made investors look more closely at their investments, and at what institutions are doing with their money, whereas, in the past, investors were probably not lifting the veil as much.”