The fallout from the collapse of Lehman Brothers in Europe continued apace yesterday as Deminor, the Brussels investor rights group, began a legal action aimed at recouping billions of dollars of losses for the bank’s creditors.

Deminor said that Lehman vehicles had issued an estimated $34 billion (£19.3 billion) of bonds and other structured credit products across Europe in recent years, some of which had been sold on to retail investors.

It said that it had been swamped by requests from creditors trying to recover assets and would be forming a representative group.

It argued that the bonds were guaranteed by Lehman’s Wall Street parent, which is in Chapter 11 bankruptcy protection from its creditors.

As well as taking legal action against any relevant Lehman entities in Belgium, the Netherlands and the US, Deminor said that it would pursue claims against intermediaries and other brokers who had sold on Lehman investments.

“In many cases, the European banks seem to have made misrepresentations about the risk profile and guarantees attached to these instruments when promoting them with their retail clients,” Deminor said.

Deminor’s move came as hedge funds across the continent were still scrambling to calculate the level of their exposures to Lehman, which filed for administration in Europe less than three weeks ago.

Hedge funds would have traded directly with Lehman as a counterparty, but would also have used the bank as a prime broker, or a supplier of financial liquidity. GLG, the hedge fund, estimated yesterday that its exposure stood at $95 million.

According to EuroHedge, a specialist hedge fund magazine, Lehman held prime broking mandates worth just under $26 billion as at January 30. It is likely that some of these clients would have cancelled contracts before the bank was plunged into crisis.

In the latest signal that the shake-out hitting hedge funds is gathering pace, it emerged that a $500 million activist European hedge fund run by Guy Wyser-Pratte, the New York arbitrageur, had slammed the door on investors trying to withdraw their funds.

Directors of the Wyser-Pratte Euro Value Fund, which targets underperforming medium-sized companies across the Continent, told investors on Tuesday that it was suspending redemptions with immediate effect.

They said that they had decided on the move, in consultation with the fund’s investment manager, to prevent a potential fire sale of assets that would have hit investors who stayed with the firm.

The continued financial seizure gripping the credit markets was also underscored as Sigma Finance, a $27 billion special investment vehicle (SIV) managed by Gordian Knot, the hedge fund, ceased trading and prepared to call in administrators.

Investors are expected to lose billions of dollars on the failure. Sigma was forced to shut down after failing to fulfil a repo agreement, which saw its credit ratings slashed.

There is only $2 billion held in the vehicle to cover $6 billion owed to senior medium-term noteholders. Last night the SIV’s managers were working on the appointment of a liquidator for the vehicle.

Zurich Financial Services said yesterday that it had taken a hit of $275 million from the collapse of Sigma, in which it had invested as part its $200 billion group investment portfolio.

Zurich previously announced a $295 million impairment on its stake in Lehman Brothers, the defunct investment bank.

The power to freeze

When times get tough, hedge funds have absolute power to suspend redemptions, leaving investors with very little choice but to wait for the situation to improve.

Like all investments, the key lies in the small print. Somewhere in a fund’s glossy sales brochure will be a list of terms and conditions, one of which will typically give the fund’s directors the discretion to freeze withdrawals.

Larger funds might detail the circumstances in which the directors can impose a freeze, such as if the principal market on which the fund trades is closed for a substantial period, or it becomes impossible to retrieve assets because of the collapse of a major counterparty.

Documentation for one hedge fund seen by The Times insisted that investors give directors discretion to suspend withdrawals “during any period when disposals of investments cannot be effected normally or without seriously prejudicing the interests of shareholders”.

Lawrence Cohen, QC, a hedge fund specialist at Wilberforce Chambers, said that either way, investors have willingly signed a contract, leaving them with very little negotiating power if the fund chooses to bolt the door.

How long investors remain barred from cashing in their money is less clear, but lawyers said funds cannot expect to hide behind emergency suspensions once a situation improves.

Rupert Boswall, a partner at Reynolds Porter Chamberlain, said most fund contracts would state that the suspension should be lifted as soon as possible.

(Michael Herman)

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