Selling Securities Class Action Claims to Realize Value

Considerations for managers winding down a hedge fund

David P. Abel, Managing Attorney, U.S. Market Advisors Law Group PLLC
Originally published in the June | July 2020 issue

The coronavirus chaos spreading through the financial markets is driving some hedge funds and other private funds to shut down.1 During this tumultuous time, managers tasked with liquidating funds must nonetheless dutifully conduct value realization due diligence. This note is intended to aid affected managers by providing considerations for the disposition of certain illiquid assets—specifically, the selling of future securities class action (and related legal) recovery claims. 

The information may also be useful for funds continuing as a going concern but still have a need for returning outside capital.2 In any event, selling the rights to legal claims can aid fund managers by providing immediate liquidity while lessening ongoing administrative burdens. Fund stakeholders can likewise benefit by receiving adequate compensation without incurring the downside risk of a prospective claim. 

Though COVID-19 is causing unprecedented financial woes, veteran hedge fund managers know that fund shutdowns are commonplace.

The niche industry of fund closures

Though COVID-19 is causing unprecedented financial woes, veteran hedge fund managers know that fund shutdowns are commonplace.3 In fact, hedge fund closures notably outpaced launches in 2019. According to industry tracker Hedge Fund Research, 738 hedge funds closed, while only 480 new funds launched.4 Because wind-downs have been an integral part of the hedge fund business, a niche industry has developed for assisting managers with value realization at the final stage. Though liquidating publicly traded securities may not require the aid of an advisor, monetizing alternative or illiquid assets may necessitate the assistance of a specialist. In addition, there may be hidden value beyond the assets listed on the fund’s balance sheet. Specifically, an inquiry should be made into whether assets have securities litigation claims of any worth. Before delving into how to make such an assessment, it is useful to first understand how a future securities claim derives its value.

The premise of a securities class action claim 

Simplistically, a typical securities fraud class action alleges that (a) an issuer and/or its executives made material false statements that inflated a company’s stock price, (b) certain investors purchased the stock during the period when the price was inflated, (c) an event occurred exposing the fraud and causing the stock price to decline, and (d) under securities laws, investors have a claim for the losses suffered as a result of the fraud. When a securities lawsuit results in a monetary award, impacted investors can make a claim for their respective portion. Therefore, if a hedge fund is in the affected class, it may ultimately receive money for its claim… or it could sell that prospective claim today for real dollars. 

Searching the portfolio for value

To locate dormant securities claims, the search should begin in a fund’s historical trade records. Even if a fund had a minimally diversified portfolio, odds are good that it has a cognizable legal claim. Approximately one in 18 companies listed on U.S. exchanges was the subject of a securities class action in 2019.5 The likelihood that U.S. exchange-listed companies were subject to a securities class action increased for a seventh consecutive year, from 2.6 percent in 2012 to 5.5 percent in 2019.6 Further, securities class action filings against S&P 500 firms in 2019 occurred at a rate of 7.2 percent.7  

Billions of dollars in settlement payouts to investors

A vast number of such lawsuits result in monetary settlements to compensate damaged investors. Over $105 billion, comprising more than 1,800 successful cases,8 has been awarded since 1996.9  In 2019 alone, there were 101 approved settlements filed in the U.S. valued at $3.17 billion.10 At present, there are more than 500 securities class actions still awaiting settlement or some other final outcome.11 Consequently, securities class action claims can represent substantial value added for a portfolio that once traded public securities. 

1 in 18

Approximately one in 18 companies listed on U.S. exchanges was the subject of a securities class action in 2019

The expanding scope of claims across countries and instruments

Class action settlement awards, however, are not limited to investors trading common stock. Funds may likewise have claims for a variety of other financial instruments in their portfolio. Market manipulation and antitrust class action lawsuits have yielded billions of dollars in recoveries for products including, among other things, currencies, forwards, futures, options, rates, and swaps. A few recent examples include (a) a $2.3 billion settlement for investors who traded Foreign Exchange (FX) Instruments,12 (b) a $590 million settlement for investors who traded instruments tied to U.S. Dollar LIBOR,13 and (c) a $505 million settlement for investors who transacted ISDAfix instruments.14 Even digital assets and cryptocurrencies have been in existence long enough for some class action legal claims to have been resolved. For example, in early 2020, a $25 million settlement was announced on behalf of investors who participated in the Tezos initial coin offering.15

Neither are shareholder claims limited to U.S. courts or investments. A growing number of countries have developed investor protection laws allowing monetary recoveries. At least 44 securities class actions were filed in Canada over the last five years.16 Outside of North America, approximately 290 securities litigations were filed since 2015.17 Ongoing litigation for which there may be future claim recoveries truly spans across the globe and industries, such as shareholder actions against Volkswagen in Germany, Danske Bank in Denmark and Petrobras in the Netherlands.18

How the legal claim selling process works

By understanding the breadth and depth of future legal claims a portfolio might contain, a manager can more fully appreciate the virtue of monetizing such claims when liquidating. To exact value, however, a fund manager needs a reputable buyer. Lake Avenue Capital, LLC is one of a few such firms that buys future securities class action settlement claims from private funds that are closing or returning capital to investors.19 Following are highlights from a recent conversation with the firm’s founder, Shane Kinahan, who provided firsthand knowledge of the claim buying process. 

“The first step for us is the execution of a non-disclosure agreement to give the fund assurance that all trading information will be handled appropriately,” said Kinahan. Once executed, the claim buyer should provide all necessary details on the scope and format of the data needed to conduct the analysis. The private fund will then deliver its historical trade data to the claim buying firm. Lake Avenue frequently works with a fund’s custodian or administrator if sufficient trade records are not internally available. “Accessing complete trade records benefits everyone. It speeds up the process and ensures the fund receives the best possible offer,” stated Kinahan.

The next step is for the claim buyer to analyze a fund’s portfolio for securities claims. Lake Avenue declined to disclose the details of how its proprietary valuation model works. Kinahan did, however, relay that the essential analysis is matching a fund’s portfolio against the hundreds or thousands of securities class action matters where a settlement is pending or may occur. “After determining the potential eligibility for future settlement claim payments, Lake Avenue assigns a dollar value to all future claims in the portfolio. We then make a fair purchase offer, sometimes in less than a week from when we started the trade analysis,” said Kinahan. 

Once a purchase agreement is executed, a claim buyer should be willing to allocate the payout according to the fund’s specifications. Lake Avenue, for example, can provide a schedule breaking down payment amounts for each relevant account and then wire the respective proceeds directly to each account. Lastly, after confirming the money has transferred correctly, the transaction should be complete.

The cost benefit analysis of selling future claims

Upon receiving a future claims purchase offer, a liquidating hedge fund should consider its options. A key consideration for many funds is whether keeping a fund operational for the purpose of self-filing claims makes economic sense. On the one hand, a fund could hold on to the claims and monitor whether settlements are reached, and damages paid out at the anticipated maximum amount.  On the other hand, it could sell the claims now and achieve immediate liquidity, but possibility at a discount. 

If a liquidating fund decides to keep its claims, it should be aware that settlements can take years to materialize, if ever. “In doing this for more than a decade, we’ve found that the average securities class action settlement takes a little more than four and a half years from the initial complaint filing to a claims administrator making a payout,” said Kinahan.20  

Final class action settlement amounts, and individual claimant amounts, can also be unpredictable. For example, even if a class action settlement is reached by the parties, a judge has the power to alter or void the agreement. Moreover, an anticipated settlement disbursement plan of allocation may encounter unforeseen issues that impact the recoveries investors receive. One scenario in which that situation could arise is if more investors file claims than estimated, thus causing individual claims to receive a smaller proration of the total settlement amount. 

Another crucial consideration for the fund is to understand the scope of what it is selling. Lake Avenue, for example, typically purchases the entire portfolio unless the fund requests otherwise. “We believe this simplifies the process for the fund and maximizes the purchase offer,” said Kinahan. Even so, a fund should evaluate whether selling certain claims might impact any legal matters in which it is involved. Carving out a specific claim or security from a purchase agreement may be necessary. Similarly, restricting the sale to a portion of a portfolio might be optimal for managers returning outside capital but still trading their own capital. For example, a fund transitioning to a family office might only sell rights related to outside capital and then internally manage its own claims going forward.  

Finally, funds that have historically used a third-party legal services vendor to file securities class action claims should confirm the claims buyer has a plan for a seamless transition.21 Importantly, a buyer should have a process that accounts for submitted but not yet disbursed settlement recovery claims. If applicable, the buyer should be willing to coordinate with the vendor in a manner that minimizes the fund’s obligations. “At least for Lake Avenue, to the extent there is overlap, we always want to honor existing agreements between a fund and its legacy claims filer,” said Kinahan.

Conclusions on the selling of a closing fund’s legal claims

Closing a fund can be complex. Managers often have the difficult job of shutting down promptly while ensuring stakeholders are distributed all possible value. The selling of legal claims could aid managers in this situation by reducing ongoing administration costs, and at the same time, providing liquid cash when it might be most desired. Therefore, as part of the fund wind-down process, managers should consider selling future securities class action and other legal claims contained in its portfolio. 

  1. See generally Robin Wigglesworth, Laurence Fletcher & Ortenca Aliaj, Coronavirus turmoil delivers shock to the hedge fund industry, Financial Times (Mar. 27, 2020),
  2. See generally, Robin Wigglesworth, Lindsay Fortado & Laurence Fletcher, Diminishing returns: hedge funds look to keep it in the family, Financial Times (Jan. 25, 2019)  
  3. See supra note i (“Hedge funds have already suffered investor outflows for 13 of the past 17 quarters — with buoyant markets helping to keep the industry’s assets under management steady at about $3tn — and the number of firms has shrunk for five consecutive years.”).
  4. Hedge Fund Research, New Hedge Fund Launches Fall and Liquidations Rise to Conclude 2019 (Mar. 27, 2020).
  5. Cornerstone Research, Securities Class Action Filings—2019 Year in Review, at 11 (Jan. 2020) (report created in collaboration with the Stanford Law School Securities Class Action Clearinghouse).
  6. Supra note v at 11.
  7. Supra note v at 12.
  8. Cornerstone Research, Securities Class Action Settlements—2019 Review and Analysis, Fig. 1 at 1 (Jan. 2020) (report created in collaboration with the Stanford Law School Securities Class Action Clearinghouse)
  9. The year 1996 is key point in time, as modern era securities fraud class action litigation dates to the passage of the Private Securities Litigation Reform Act (PSLRA) that was signed into law at the end of 1995.
  10. Securities Class Action Services, The Top 100 U.S. Class Action Settlements of All-Time, As of December 31, 2019, ISS SCAS, at 2 (Jan. 2020) (free registration required).
  11. See supra note v, extrapolation of Fig. 4 at 5: Class Action Filings [] Index Annual Number of Class Action Filings 2005-2019 and Fig. 15 at 16: Status of Filings by Year–Core Federal Filings 2010-2019. 
  12. See Foreign Exchange Antitrust Litigation claims administration website. 
  13. See U.S. Dollar Libor Settlement claims administration website. 
  14. See ISDAfix Antitrust Litigation claims administration website.
  15. Ross Todd, Judge Gives Early Approval to $25M Class Action Settlement in Tezos ICO, (Mar. 20, 2020) (registration may be required).
  16. Bradley A. Heys, Robert Patton & Jielei Mao, Trends in Canadian Securities Class Actions: 2019 Update, NERA Economic Consulting, Fig. 1 at 2 (Mar. 19, 2020). 
  17. Securities Class Action Services, The Top 25 Non-North American Settlements As of December 31, 2019, ISS SCAS, Fig. 3 at 5 (Jan. 2020).
  18. See generally, legal actions organized by International Securities Associations and Foundations Management Company (ISAF Management).
  19. See generally, Lake Avenue Capital website.
  20. Kinahan’s assessment tracks with a recent Cornerstone Research report that found, on average, large securities cases take about 3.5 years between the filing of the lawsuit and a settlement announcement (a couple steps prior to disbursement).  Cornerstone Research, Securities Class Action Settlements: 2019 Review and Analysis, at 6 (Jan. 2020) (“smaller cases typically settle more quickly. In 2019, cases with less than $25 million in [damages] settled within 2.0 years on average, compared to 3.5 years for cases with [damages] greater than $500 million.”).  After a tentative settlement is announced, it routinely takes several months or more for funds to be disbursed.  The additional time is necessary so a class action can go through the required notice and administration process.
  21. Active (not shutting down) hedge funds not currently filing (or having a third-party vendor file) claims in current securities class actions settlements should consider whether doing so would fulfill its fiduciary obligation to stakeholders. See Scott Pomfret, Fund Managers Must Evaluate Their Claims Policies to Avoid Breaching Fiduciary Duty, Hedge Fund Law Report (Jan. 20, 2020) (“Given the number of third-party providers who facilitate class-action-claim filing as their businesses, [ ] it would be difficult for an adviser to justify making no claim at all unless it had expressly disclaimed the duty to do so.”) (subscription required).