Hedge Fund shareholder activism: Is it really worth the game? The Dynamic Decisions case.

On November 12th, 2009, the U.K.’s Serious Fraud Office (“SFO”), an independent government department that investigates and prosecutes fraud and corruption cases, announced that it is probing the London-based, Dynamic Decisions Capital Management Ltd., after the matter was referred to it by the Financial Services Authority.
The SFO’s investigation is the last act in a death spiral scenario that started in March 2009 before the Grand Court of the Cayman Islands. Because of the lack of transparency of the administrative processes (or probes) used by the U.K and Cayman Islands authorities, in comparison to what can be achieved from the U.S. authorities, it is difficult to acquire details on what really happened. Thus, the apparent lack of information surrounding this case is fuelling speculation about what really happened and numerous are those who already want to see Alberto Micalizzi, Dynamic’s founder, join the hedge fund fraudster Hall of Shame. Alberto is denying all allegations and believes that investors will recover 100% of their money.
At HF Appraisal, we have a different outlook on the events which led to the involvement of the SFO in Dynamic’s story, and we will try to extrapolate on what really happened since mid-December 2008. The current case will also allow us to illustrate the funds’ shareholders legal strategy to force the winding up of the fund.
In order to understand the story, we need first to analyze the chronology of the events.
February 20th, 2009: Micalizzi sent a letter to the investors explaining that the firm scaled back its equity and options holdings in December and bought “fixed income instruments backed by solid assets”. According to the letter, settlement of those purchases would be delayed until February because of “credit market conditions”,
Last week of February 2009: Two investors complained to the fund, and the board hired the law firm Dechert LLP for an opinion on the oil-backed bond transaction.
February 27th, 2009: In another letter to the investors, the investment manager announced that investors’ withdrawals would be suspended and that Micalizzi resigned from the board of the master fund to avoid a conflict of interest. According to the investment manager, Micalizzi was barred by the board to speak to the investors thereafter.
March 13th, 2009: A conference call was organized between the funds’ shareholders and the board of directors. In this call, Humphrey Polanen, a former director of the funds, relayed Micalizzi’s message to investors that the fund had “substantial” losses last year and assets may have fallen to as low as $20 million, excluding illiquid assets according to a court document.
March 23rd, 2009: A petition was submitted by Zolfo Cooper, a restructuring firm, appointed by two investors in the two feeders funds, Strathmore Capital LLP, based in London, and Cadogan Management LLC of New York. The shareholders won their petitions for the nomination of a provisional liquidator on the feeder funds, but Dynamic Decisions investment manager opposed the request on the master fund.
March 26th, 2009: Humphrey Polanen resigned as a director.
April 2009: Grant Thornton LLP is named provisional liquidator.
May 22nd, 2009: Hugh Dickson and Stephen Akers, partners at Grant Thornton LLP, were named the fund’s official liquidators by the Grand court of Cayman Islands. The liquidators said they expect to organize a meeting of creditors within the next 28 days to report on their findings.
November 12th, 2009: The fund’s liquidators, Grant Thornton LLP, said they were investigating corporate bonds the fund bought late last year. On the same day, the SFO announced its investigation.
In the Cayman Islands, which are British territories, companies can be liquidated, according to the UK Government’s Insolvency Service, for the following reasons:
Members' voluntary liquidation (or members' voluntary winding up). This is done when the shareholders of a company decide to put the company into liquidation, and there are sufficient assets to pay all the debts of the company, i.e. the company is solvent.

Creditors' voluntary liquidation (or creditors' voluntary winding up). This is done when the shareholders of a company decide to put the company into liquidation, but there are not sufficient assets to pay all the creditors, i.e. the company is insolvent.

Compulsory liquidation (or compulsory winding up). This is done when the court makes an order for the company to be wound up (a “winding-up order”) on the petition of an appropriate person. If there is more than one director, all the directors must jointly present the winding-up petition. A single director cannot present a winding-up petition.
If you are a director or a shareholder and you are also a creditor of your company, you may wish to present a winding-up petition on the grounds that the company cannot pay its debts.
In a fund structure, shareholders become creditors of the fund has soon as they submit a redemption request and that the fund accepts this withdrawal. We can safely assume that the two investors, Strathmore and Cadogan, placed redemption orders and received confirmation, from the fund’s administrator PNC, before the fund announced on February 27th that redemptions were suspended. The fact that the two shareholders became creditors on that day and, in the eventuality of a liquidation (i.e. “winding-up”) of the company, they would have been placed in a preferential position, in the scheme of collocation, with respect to the other investors. In other words, being preferred to other claimants (i.e. investors), Strathmore and Cadogan would have a higher chance of receiving any payment from the proceeds of sale (i.e. liquidation of the fund).
One of the remaining conditions to wind-up a company is for a claimant to demonstrate that the fund was insolvent. In this connection, Strathmore and Cadogan alleged, in their petition, that the “[…] board had little information concerning the investment in bonds, and were not even sure if the bond were genuine”. The two investors also claimed that there was “[…] gross mismanagement and misfeasance”; thereby leaving the judge almost no choice but to appoint a provisional liquidator. The petition was further supported by a Dechert LLP report which cited “[…] vague concerns about one of the potential buyers [for the bonds] on the table”.
The resignation announcement of March 26th by Humphrey Polanen from the fund’s board is also puzzling since he is the one that indirectly triggered the liquidation process after his phone call with the fund’s investors on March 13th.
Thus, in April 2009, the Grand Court of the Cayman Islands appointed Grant Thornton as the provisional liquidator. The role of the firm, at this point, was to investigate the business to discover, protect and recover assets as well as produce a report to the court, which then decides whether or not to liquidate the company. In a statement dated May 25th, Grant Thornton announced that “[…] a number of allegations have been made as to the remaining asset value and the nature of the assets held, and the master fund has been unable to pay a number of large redemption requests”. Apparently, this statement does not bring anything new to the table, as the Grand Court had already decided on May 22nd to call for the liquidation of the funds and appoint the provisional liquidator for the task.
Today, almost 9 months after the suspension of the redemptions by the fund, the liquidator is still investigating the purchase of the oil-linked bonds and the investors are still waiting to see how much they will recover from their investments in the funds. Moreover, the existence of the fraud is yet to be demonstrated.
In sum, it appears that the forced liquidation strategy adopted by Strathmore and Cadogan is a good one, as it may enable them, as creditor, to recover their investments, especially if the fund has sufficient assets and the legal requirements of a winding-up order are satisfied. However, it seems that the investors’ action in court has not helped speed up the asset recovery process. We are surprised not to see more investors in the Hedge Fund industry use this legal action (or mechanism), especially following the wave of redemption suspensions announced at the beginning of the year.
The role of the board of directors in this kind of process will have to be investigated to see if they understand the implications of liquidation and if they took the proper decisions in either accepting or contesting a petition for liquidation.
No matter the issue, the Dynamic story appears to be strong testimony for implementing a board of directors with the necessary skills, experience and involvement to choose the best alternatives during a crisis and for the ultimate benefit of the shareholders. It appears, in the present case that all the processes seem to have escalated beyond anyone’s control and not necessarily for the benefit of the shareholders. We will have to wait longer to find out the outcome of this story, but for the time being the Dynamic case has assuredly, and perhaps unnecessarily, tarnished the already fragile reputation of the hedge fund industry.

Disclaimer: Hedge Fund Appraisal has not performed any due diligence on the funds mentioned in this article. All the information was collected from public sources, which have not been verified. Nor does this article constitute a legal opinion.