On July 23, 2008, the New York Supreme Court, Commercial Division, New York County, issued a decision that is important for all prime brokers. Written by Justice Charles E. Ramos, the decision dismissed the claims that investors in hedge fund Wood River Partners, L.P. (“Wood River”) had asserted against the fund’s prime broker, UBS Securities, LLC (“UBS”), for allegedly causing the hedge fund’s collapse. Eurycleia Partners, LP v. UBS Securities, LLC, No. 600874/07 (N.Y. Sup. Ct. July 23, 2008). This decision is important to the prime brokerage community because it reaffirms the principle that investors in entities that hold accounts with a prime broker generally lack standing to sue, and are owed no fiduciary duties by, the prime broker.
In 2005, Wood River failed after its manager, John Whittier, amassed an alleged 30% stake in the stock of Endwave Corp., a micro-cap telecommunications company for which UBS was a market maker. In May 2007, Wood River’s limited partners sued UBS for $200 million, alleging UBS used inside information obtained in its capacity as prime broker to manipulate the market for Endwave stock by (a) improperly making Wood River’s Endwave shares available to borrow by short sellers in order to generate allegedly lucrative stock lending fees for UBS despite the fact that such resulting short selling was against the interests of Wood River, (b) taking a large proprietary short position in Endwave stock and (c) leaking information regarding Wood River’s anticipated sales of Endwave to create additional short interest that generated further stock lending fees and enhanced the value of UBS’s short position to the detriment of Wood River’s long position in Endwave stock. The plaintiffs alleged that such actions depressed the price of Endwave stock and thereby dissipated the value of their investments in Wood River, which had nearly two-thirds of its portfolio concentrated in Endwave stock. The complaint asserted claims against UBS for fraud, constructive fraud, breach of fiduciary duty, aiding and abetting, gross negligence, tortious interference with contract and unjust enrichment.
In dismissing all claims asserted against UBS, the court recognized that the asserted claims largely belonged to the hedge fund itself rather than the investors, and that the investors themselves had no direct relationship with UBS. Specifically, assuming the facts set forth in the complaint were true (as is required of a court on a motion to dismiss), the court held that “UBS’s alleged misconduct resulted in a direct injury to the partnership . . . . rather than . . . an independent injury to the limited partners,” that the claims therefore needed to be “asserted directly or derivatively on behalf of the partnership” and that the investor plaintiffs consequently lacked standing.1 The court further held that “UBS’s position as prime broker, clearing broker, and custodian” for the hedge fund was “not sufficient to establish the existence of a fiduciary relationship” that would have required UBS to alert the investors to the fact that Wood River had amassed Endwave stock in a concentration greater than the fund’s offering documents permitted and had failed to file SEC Forms 3, 4, or 13D reporting the position. Finally, the court held that the plaintiffs had failed to allege that UBS provided the substantial assistance necessary to establish aiding and abetting liability because “Whittier’s alleged scheme ran counter to UBS’s, insofar as Whittier allegedly could not complain to authorities” about UBS’s asserted conduct “because that would have revealed his own violation of federal securities laws.”
The decision represents the second legal victory for a prime broker in less than a month. On June 27, a Southern District of New York jury rendered a verdict in favor of Bear Stearns Clearing Corp. (“Bear Stearns”) rejecting an attempt by the bankruptcy trustee for the failed Manhattan Investment Fund to hold Bear Stearns liable for $125 million in alleged fraudulent transfers (plus millions more in interest) by that hedge fund into its prime brokerage account. Schulte Roth & Zabel represented Bear Stearns at that trial.