SECRET LIVES OF HEDGE FUND LAWYERS
by Caitlin Lui
Gathering courtroom intelligence can be a lucrative second career.
Long before closing arguments, and even before key witnesses have testified, Loring Justice sits in his law office in Knoxville, Tennessee, analyzing the case and forecasting the verdict.
He is not doing so for the plaintiff or the defendant, nor is he talking to reporters covering the case. His eager audience consists of hedge fund traders.
"This is not a frivolous lawsuit," Justice might tell the traders in a conference call. "There's a scientific basis for saying pharmaceutical X causes adverse event Y, and District Judge so-and-so's ruling will be upheld. And the reason is because there are such-and-such precedents in the U.S. Court of Appeals for the Z Circuit."
Hedge funds are a fast-growing and lucrative practice for lawyers across the nation. But instead of drafting contracts or registration statements, some attorneys are performing a very different, clandestine line of work: gathering legal intelligence so that hedge funds can make big-money investment decisions.
These lawyers pore over every document in the court files, mine daily transcripts, and monitor hearings for clues to how a judge or jury might be leaning. They join the courtroom audience and scribble notes like journalists, with the hopes of getting the big scoop when important news breaks. While this line of work is usually too sporadic to be a full-time career, it can be quite profitable, with lawyers earning as much as $800 an hour.
To gain an informational edge, hedge fund traders want to handicap the outcome of product liability or bankruptcy cases. In some cases, they don't care who wins or loses; their concern is that the market will overreact regardless of the verdict.
"If the jury verdict comes down, and somebody knows what it is a couple of minutes before it goes out on the wires, they could either buy or sell at a slight advantage," says Paul Seader, executive director of Hedge Fund & Private Investment Resource Center, a nonprofit research organization in New York. "You're not trading on inside or nonpublic information. You're trading on public information that's available a split second before the general public becomes aware of it. And that may be all the difference needed to make a significant profit or avoid a loss."
Hedge funds' appetite for legal intelligence is surging along with their ranks. There are now more than 7,500 hedge funds, a 50 percent increase from just four years ago, and they are managing $1.7 trillion in assets, according to Hedge Fund Research Inc.
These funds employ a variety of investment strategies, including one that is driven by "events"-a category that includes lawsuits and bankruptcies, as well as deals and mergers, says Scott Esser, C.O.O. of H.F.R.I. A decade ago, only 4 percent of assets under management were event-driven. Now, it's the strategy behind 13 percent of the hedge fund world.
"Investors are looking for very quick analysis," says Edward Black, co-chair of the intellectual property practice at Ropes & Gray in Boston. "You need to understand the implications of what's happening immediately. You can't just hear about it and say, ‘I need three weeks to think.' When we do this work, we perform the service on market time. Minutes and seconds matter."
Notoriously secretive, hedge fund traders rarely inform the lawyers they've hired how they intend to profit from the court information. But the lawyers can sometimes make an educated guess.
"In patent and trade secret cases, the big concern is you'll be enjoined from selling products or services," says Mauro Premutico, a former intellectual property litigator. "If you knew they were going to lose the case, you'd have an inside track."
Patent disputes can be critical to the bottom line of pharmaceutical, medical device, and computer technology companies. Fund managers are especially fond of so-called pure plays-companies in a single line of business, such as managing intellectual property rights. An example is N.T.P., the tiny outfit-and patent holder-that won $600 million from Research in Motion last year to settle its infringement lawsuit over BlackBerry technology.
Bankruptcies also pique fund managers' interest, and they hire lawyers to provide them with a complete picture of a company's capital structure, liabilities, and debts before they swoop in, says Daniel Strachman, a consultant and author. Asbestos, tobacco, and pharmaceutical cases-litigation with potentially far-reaching consequences due to the number of plaintiffs and amount of damages sought-are also tracked closely by hedge funds.
One lawyer, who asked not to be identified, believes hedge funds may be purposely staking out contrarian positions. Rather than favoring the likely winner or shorting the probable loser, fund managers are placing bets-through puts and call options-that the market will overreact to whatever verdict is rendered.
As an example, he cites the case of TiVo. In April 2006, TiVo won a $74 million patent infringement suit against EchoStar. Following the verdict, TiVo stock price spiked to a two-year high of $8.65. But in the months since, as the market digested the information more fully, TiVo shares tumbled.
"If you're really smart, you already know the best way to make money is to bet against the overreaction of the market," the lawyer says.
As is typical when it comes to hedge fund investing, confidentiality is the rule of the game. Justice would describe what he does for hedge funds using only hypothetical scenarios. None of the lawyers interviewed for this article, even those promised anonymity, would identify their investor clients.
Still, the lawyers are fairly easy for courtroom regulars to spot. Like reporters, they take copious notes. But unlike reporters, they tend to be well dressed. They always sit alone and never introduce themselves to the lawyers on the case.
Karl Hampe, a litigation consultant for B.D.O. Consulting in New York, says he sometimes notices more than a half dozen such people during a trial. They have a tendency, he says, to perk up during testimony that would put most people to sleep: data on a company's manufacturing capacity, minutiae about the sales force, details on the corporate structure.
"I see people in the back of the courtroom, taking notes on all this," Hampe says. "They're there to gather business intelligence."
Loring Justice, Esq.
11911 Kingston Pike
Knoxville, TN 37934