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In addition to risks and returns, advisers need to worry about moral and ethical issues

Published in Investment News
May 20, 2016 @ 9:30 am
By Jeff Benjamin

Heads up, financial advisers, because some of the latest performance from a fledgling investment category known as litigation finance could start catching the attention of your clients.

The idea of investing capital to help finance a lawsuit is not completely new, but the May 16 passage of a provision of the 2012 JOBS Act could pave the way for lawsuit-investing pitches at the retail investor level.

There is no denying the risks that a lawsuit could lose or result in a minimal settlement. But when the latest figures are showing annualized returns in the 90% range, advisers should expect the noise surrounding litigation finance to keep getting louder.

“That’s what you get in these low-interest-rate markets; all the weird [stuff] comes out,” said Ed Butowsky, managing partner at Chapwood Capital Investment Management.

Mr. Butowsky is not a fan of investing in lawsuits, and wouldn’t advise his clients to do so, the same way he is personally opposed to investing in marijuana-related businesses.

Part of his issue with litigation finance is that he believes gathering investment capital to finance lawsuits will lead to more lawsuits.

“I don’t like the business, and no matter how good it looks I’m not going to invest in that because I just don’t like to be associated with that kind of stuff,” he said. “There’s lots of things where the returns look strong, but you also have to check your moral character. I don’t like extortion and that’s what I think a lot of plaintiff attorneys do.”

It would be difficult to dispute that the returns do look good.

TrialFunder, which funded its first lawsuit last summer, is touting a 108.7% return over nine months from the settlement of a police brutality case.

In another investment on the platform, investors gained 98% by advancing the settlement payout from a trip-and-fall injury lawsuit.

Amoush Hakimi, a practicing attorney and TrialFunder chief executive, said he is just weeks away from rolling out a multi-lawsuit fund to be offered on the platform.

For now, the litigation finance platforms are all still limited to accredited investors, but the May 16 expansion of the JOBS Act paves the way for such platforms to potentially solicit capital from retail-class investors.

Mr. Hakimi said he is already eyeing a retail platform, but that he is “waiting for more clarity on the rules.”

The returns on these types of investment are so high, he said, because “most people price the risk way too high, which kind of accounts for the high returns.”

“Part of our mission is to show that this is a viable alternative asset class for non-institutional investors,” Mr. Hakimi added.

Some of the wrinkles that will need to be ironed out on any retail-oriented platforms will involve the fee structures, which currently include a 20% take of the performance, but no ongoing management fee on most platforms.

Another rub that might turn off some investors is the lack of liquidity.

The platforms allocate capital to lawsuits at various stages, but it typically means at least of couple of years of waiting for a payoff in the form of a settlement.

Former investment banker Jay Greenberg co-founded the LexShares litigation finance platform in November 2014 because he saw the potential returns as “incredibly uncorrelated” with traditional investments.

“What drew me to this market is that the return profile is just associated with the courtroom vacuum,” he said. “I did not know a lawsuit could be a capital asset.”

Operating virtually on the opposite end of the type of lawsuits funded on TrialFunder, Mr. Greenberg said his focus is on commercial litigation.

LexShares, which deployed $5 million last year, is slated to deploy $20 million this year helping to finance lawsuits.

Mr. Greenberg said he has so far not funded a deal that lost money, and said his two most recent lawsuits returned 93% and 88% net of fees.

Paul Schatz, president of Heritage Capital, said he had never heard of litigation finance, and described it as “definitely an out-of-the-box, non-correlated investment with huge upside and downside.”

“I would have to put it in the very aggressive category with the potential for a homerun or a strikeout,” he added. “The risks are multi-fold, including the unknown. I would have to get a very deep understanding of the process before I would ever consider investing, but it’s definitely something new and sexy.”

Dick Pfister, founder and chief executive of AlphaCore Capital, attributed the high returns to the relative lack of competition. But said that is changing rapidly, and the investment returns should be expected to start dropping.

“You’ve got more investment platforms searching for lawsuits, so the lawyers now have more options, and the lawyers are going to bid for the lowest loan yield,” he said.

But beyond the investment pros and cons, Mr. Pfister also sees the moral and ethical sides of the debate over litigation finance.

“On one hand, you’ve got the guy who couldn’t fund a lawsuit against a big corporation and now has access to capital,” he said. “But the flipside is that this will start to fund frivolous lawsuits, and those will offer higher yields because they have less chance of winning.”

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