In Hot Pursuit of Hidden Loot

FAREWELL TO CONTINGENCY FEES. THIS GOLDEN AGE of financial fraud has opened up a new vein of capital for lawyers. Hedge funds, endowments, and institutional investors are pouring hundreds of millions of dollars into partnerships created by the lawyers in return for a share of any court awards, settlements, and recovered assets.

The lawyers are attracting so much lucre that the practice of law may never again be the same. One big plus for investors in these partnerships is that the major competitors in the field are feckless, under-funded securities regulators, including the Securities and Exchange Commission.

The latest entrant is Canadian-born lawyer Martin Kenney, an ace at asset recovery. Kenney, who lives in the British Virgin Islands, is especially adept at sniffing out fraudster hidey-holes in far-flung places like Africa, the Caribbean Islands, and Switzerland; he has hunted for assets in more than 50 countries. Kenney currently represents a European bank trying to recover $10 billion from two Madoff feeder funds, and some U.S. investors taken in by a huge currency-trading scam.

So many crooks have salted away so much loot -- an estimated $30 billion worldwide -- that Kenney and some partners have decided to create a private fund, called Echemus, to raise $150 million to bankroll recovery efforts. These will be made on behalf of fraud plaintiffs and claimants of legal awards, who will receive 70% of any disgorgements; the limited partnership divvies up the remaining 30% among itself and the investors.

Echemus hopes to provide investors with pre-tax annual returns of 35%, net of fees, expenses, and carried interest. The investment term is 10 years.

WHY WOULD CLAIMANTS sign on with Kenney? Often because they are left nearly penniless after investing with someone like Madoff and no longer can afford private legal counsel. While they could turn to the SEC, which pursues stolen funds in jurisdictions where it has a legal standing, the agency has a spotty record when it comes to actually recovering the loot.

Between 1995 and 2001, the SEC collected $426 million, or only about 14%, of the $3.1 billion owed to investors in disgorgement cases (cases where a court orders a firm or an individual convicted of fraud to turn over assets).

I tried to obtain a more current number and discovered that the SEC doesn't keep one. What's more disquieting, an audit by the U.S. Government Accountability Office released last month found material weaknesses in the agency's internal controls, which means that mistakes in its financial reports might go undetected. The GAO named "accounts payable data for payments to harmed investors" as one area affected by the weaknesses. So the number I sought may not be a good one.

JAMES LITTLE OF BALTIMORE, one of the founders of Echemus, says that "litigation financing" emerged as an investment opportunity over the past 10 years as courts in Great Britain and other jurisdictions struck down laws prohibiting investments in lawsuits.

The laws vary by state in the U.S. You can't invest in lawsuits in New York State, for instance, says Little. Earlier funds focused on bringing securities-related suits against corporations. Two companies in this field, Juridica Investments (ticker: JIL.UK) and Burford Capital, (BUR.UK)) trade in London. In the U.S., Juris Capital, which is owned by hedge funds, finances litigation.

Richard Scheff, a securities-fraud expert and chairman of the Montgomery, McCracken Walker & Rhoads law firm in Philadelphia, said there's criticism from the defense bar that this sort of investment vehicle promotes law suits.

Asset reclamation is less controversial because lawyers like Kenney generally have a court order. Nevertheless, it is an expensive and time-consuming and financially risky undertaking, often involving investigations and legal actions in multiple jurisdictions.

Firms that take such cases on a contingency basis sometimes skate near the brink of insolvency before a recovery is made, Scheff says. A limited-partnership structure, by contrast, gives lawyers the capital required for multiple cases.

Echemus already is eyeing collections on some 25 commercial-fraud and third-party liability claims with a putative value of $2.6 billion. The partnership estimates that costs will average about $5 million per case.

Finding illicit money has gotten easier over the past 25 years. Little says that during Ronald Reagan's term, money-laundering laws aimed at drug dealers facilitated the tracking and retrieval of all kinds of dirty money.

Crooks have a problem: They must hide their loot in stable jurisdictions or risk having it stolen. This gives asset-hunters a great advantage. The golden age of fraud might not be golden at all.

E-mail: jim.mctague@barrons.com