Exactly how Tremont Group Holdings plans to defend itself against claims that it was “reckless” with client money that was invested in Madoff funds is something those affected by the Madoff scandal—and really, anyone interested in how fund of fund companies conduct due diligence—will be watching.
A lead plaintiff is expected to named in the next couple of weeks in the class action suit brought against investment manager Finkelstein v. Tremont Group HoldingsInc. The complaint against Tremont says the firm acted “recklessly or with gross negligence and/or in breach of fiduciary duties” when it caused and permitted $3.3 billion—more than half of its total assets—to be handed over to Bernard Madoff. The case also names Ernst & Young for failure to perform adequate audits “despite the existence of a myriad of red flags indicating a high risk to Tremont from concentrating its investment exposure in Madoff.”
“It’s one of the biggest cases regarding Madoff. This is interesting because the feeder fund involves very solvent parent companies. There’s going to be a lot of attention surrounding this case,” says Brian J. Neville, founding partner of Lax & Neville in New York. Tremont is a subsidiary of Oppenheimer Acquisition Corporation, which is a unit of Massachusetts Mutual Life Insurance Company.
Neither defense or plaintiffs lawyers in the case responded to calls, but one securities lawyer says Tremont may have a hard time constructing a defense. Ted Eppenstein, of Eppenstein& Eppenstein, a New York-based firm that represent investors, says, “Madoff’s operation wasn’t transparent. If anything, it was secretive and that should have set off flags.” Eppenstein does think, however, that Tremont will fight the suit. He says the firm’s lawyers will point to Madoff’s reputation, the consistent returns his firm brought in and his position at the NASDAQ to say, ‘We were duped, too.’
Neville, who typically defends investment firms, speculates that Tremont could try to blame regulators. “Tremont could say it relied on the fact that Madoff Securities was a broker/dealer that was regulated and routinely audited by the NASD, now FINRA, and the SEC. There were no regulatory red flags. Madoff, and his employees, had a clean track record,” Neville says. “If anyone were to do typical due diligence by calling their peers, competitors and regulators they’d see each of those groups would come back with positive, glowing reports.” Neville represents a so-called feeder fund similar to Tremont but would not name the fund because the case against it has yet to go public.
“Feeder funds” are typically indemnified against simple negligence in the terms of their investment management agreements. The complaint against Tremont claims “gross negligence”, however, an action much more difficult to prove, according to Castle Hall Alternatives, a firm that specializes in completing due diligence on behalf of investors. Attempts to prove gross negligence are lengthy and costly, the company says. Neville says that’s part of the reason Tremont is going to fight the suit. “Most of the time, you can’t sue a hedge fund for simple negligence. You can sue for gross negligence but it’s much harder to prove,” he says.