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Investment Advisor Not Liable for Securities Fraud in Recommending Hedge Fund That Was Part of a Ponzi Scheme

On July 14, 2009, the Second Circuit Court of Appeals affirmed an order of the District Court for the Southern District of New York dismissing contract and securities fraud claims against investment advisors who recommended a hedge fund that turned out to be part of a Ponzi scheme. South Cherry Street, LLC v. Hennessee Group LLC, et al., 2009 WL 2032133 (2d Cir. July 14, 2009). Under this decision, an investment advisor who recommends investments in a fund that turns out to be a Ponzi scheme will not be held liable for securities fraud unless the investor alleges particular facts giving rise to a strong inference that the advisor either had fraudulent intent, or acted with conscious recklessness as to truth or falsity of the advisors statements to the investor.

Background

In 2001, the Hennessee Group, an investment advisor specializing in investments in hedge funds, made a presentation to South Cherry Street, LLC that emphasized Hennessee Groups unique experience and expertise in evaluating hedge funds. The presentation also extolled Hennessee Groups five-step due diligence process for selecting hedge funds and its ongoing analysis of investments made with recommended hedge funds. After receiving the presentation, South Cherry Street entered into an oral agreement whereby the Hennessee Group would recommend suitable hedge fund investments and would conduct ongoing due diligence on those investments in exchange for a 1% commission. The Bayou Accredited Fund was one of the hedge funds that Hennessee Group ultimately recommended to South Cherry Street.

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