A federal bankruptcy judge ruled that investors in Bayou Management, a collapsed, fraudulent hedge fund, are able to sue investors who cashed out before the fund failed in 2005, according to The Wall Street Journal.

One trustee suing the hedge fund, Jeff Marwil, is attempting to recover $140 million from a range of investors who cashed out before the fund’s closing. Sixteen million of the sum is profit and $126 million is the original money investors poured into Bayou.

The judge ruled that the Marwil could try and get back the entire amount. As an alleged “fraudulent conveyance,” the money was possibly given back to investors by the hedge fund managers in order to perpetuate the fraud, wrote Adlai Hardin Jr., a judge in the U.S. Bankruptcy Court for the Southern District of New York. He denied defendants’ motions to dismiss dozens of lawsuits brought by Marwil.

Marwil is suing the fund manager of hedge fund Sterling Stamos, as in early 2005, it withdrew tens of millions of dollars from Bayou, according to people close to matter. Additionally, Marwil has sued family trusts, individuals and hedge funds-of-funds, and he intends to sue several more, as well. The suits contend that money was unfairly paid out as part of the scheme by the managers to defraud investors. 

“I call it the ‘Hotel California’ syndrome for hedge funds,” said Timothy Mungovan, an attorney at Boston-based Nixon Peabody, who represents clients in five hedge fund failures in which redemptions by some investors are an issue. “You can check out anytime, but you can never leave.”

The case is raising interest as investors often pull their money out of hedge funds when they see warning signs of danger. If investors have to pay back money after leaving a fund, it would increase the risks of investing in hedge funds.

The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.

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