In the high-stakes world of hedge funds, deals are often made fast, fortunes rise and fall in weeks, and trust between partners is everything. But when that trust crumbles and when corporate rules aren’t followed to the letter the fallout can be devastating.
One of the clearest cautionary tales comes from the long, messy breakup of Scott Stagg and Gary Katcher, two former hedge fund partners whose partnership once held promise but ultimately collapsed into years of lawsuits, allegations of fraud, and millions of dollars locked up in escrow.
The dispute, which reached the U.S. District Court for the District of Connecticut in 2011, showcases what can happen when successful financiers ignore corporate formalities and blur the lines between business and personal gain.
This case wasn’t just about money; it was about governance, accountability, and the importance of keeping clean boundaries between overlapping business entities.
From Opportunity to Rivalry: How It All Began
Back in 2002, Gary Katcher, a seasoned trader in distressed debt, launched Libertas Holdings, LLC and its brokerage arm, Libertas Partners, LLC. The firms specialized in high-yield and distressed debt instruments, a niche where savvy bets could deliver outsized returns.
Katcher brought on Scott Stagg, another experienced market player, and later Mark Focht as Chief Operating Officer. Together, they didn’t just run brokerage operations they aimed to build a hedge fund empire.
By 2004, they co-founded 3V Capital Master Fund, Ltd. (3V), along with related feeder funds, to pool capital and pursue below-grade investments. To manage trading strategies, they created 3V Capital Management, LLC, while relying heavily on Libertas as their broker.
On paper, these were distinct businesses. In reality, operations, offices, and even staff overlapped so extensively that the lines blurred. This lack of separation planted the seeds of conflict.
The Transfers That Sparked Suspicion
Between 2005 and 2007, COO Focht, with Stagg’s alleged approval, orchestrated a series of multi-million-dollar transfers from 3V to Libertas. The stated reasons varied buying shares in companies, covering operating expenses, and even helping Libertas meet payroll.
But the reality was stark:
- $8.9 million went to Libertas without any legitimate claim,
- Some intended share purchases never happened,
- And much of the money simply covered Libertas’ own debts.
These transfers weren’t just sloppy bookkeeping. They were outright red flags, signaling conflicts of interest and raising questions about fiduciary duties.
By 2007, the partnership was fracturing. Stagg moved ahead on his own, creating a new fund: SV Special Situations Master Fund, Ltd. (SV). He quietly shut 3V to new investors, moved offices, and absorbed 3V’s assets into SV allegedly without Katcher’s knowledge or consent.
This was more than a business pivot; it was the start of a bitter financial divorce.
The Breaking Point: Fraud Charges and New Ownership
In 2008, Knight Capital Group, Inc., a major financial services firm, acquired Libertas. But the past couldn’t be erased.
By 2009, COO Mark Focht pled guilty in New York State court to grand larceny for misappropriating funds from 3V. That conviction further deepened mistrust and opened the door to years of litigation.
The Lawsuits: A Multi-Front Legal War
The fallout didn’t end with Focht’s guilty plea. Instead, it triggered a wave of lawsuits:
- SV (Stagg’s new fund) and 3V (the old fund) sued Libertas, Knight, and Katcher to recover more than $13 million in improper transfers.
- Defendants, while admitting to holding $8.9 million they couldn’t legally claim, argued SV had no standing to sue since it wasn’t a true successor to 3V.
- To protect themselves, defendants filed a third-party complaint against Stagg, Focht, and 3V Management, accusing them of fraud, breach of duty, and negligent supervision.
- Separately, Katcher himself filed a cross-claim, seeking over $4 million he said was owed from the sale of 3V’s general partner.
The legal battlefield was set: claims, counterclaims, and third-party actions stacked on top of one another.
The Court’s Dilemma: Who Owns What?
When the case landed before the Connecticut District Court in 2011, the judge faced a thorny puzzle.
- Standing: Could SV truly act as a “successor-in-interest” to 3V?
- Stagg claimed investors rolled over their 3V interests into SV.
- Defendants argued not all investors transitioned, and the funds were separately incorporated in the British Virgin Islands with different strategies and agreements.
- The Court noted it couldn’t even determine whether BVI law or Connecticut law applied leaving the standing issue unresolved.
- Personal Liability: Could Katcher be personally on the hook?
- Evidence showed he personally received over $100,000 from a 3V-to-Libertas transfer.
- The Court ruled he could face claims of unjust enrichment, conversion, and direct liability, even without piercing the corporate veil.
- Where the money went: With overlapping entities and loose bookkeeping, tracing ownership was nearly impossible.
- The Court appointed a forensic accounting expert to investigate.
- Nearly $9 million was ordered into an interest-bearing escrow account while the case played out.
Indemnification Battles: Passing the Buck
The defendants also tried to shift blame through third-party claims. They argued that Stagg, Focht, and 3V Management should indemnify them for any wrongdoing.
The Court didn’t buy it. Under Connecticut law, to succeed on indemnification, defendants had to prove that the third-party defendants were the primary cause of the losses. At most, the complaint alleged they contributed not that they were the main culprits.
Similarly, Katcher’s bid for contractual indemnification under the 3V operating agreement failed. The agreement only protected managers acting in good faith and allegations of misappropriation didn’t fit that bill.
Katcher’s $4 Million Claim: A Question of “Clean Hands”
Katcher’s counterclaim sought $4.1 million linked to his partnership interest in 3V. Even SV admitted it held that money without rightful claim.
But the Court wasn’t ready to hand it back.
Why? Because of the doctrine of unclean hands. If Katcher knowingly benefited from improper transfers that inflated Libertas’ value, a jury could conclude he acted in bad faith. Until that question was resolved, the funds stayed locked in escrow.
Lessons from a Hedge Fund Meltdown
While the court’s partial ruling left many questions open, the broader lessons are clear. This saga is a textbook case of what happens when financial partners fail to enforce strict governance and corporate discipline.
1. Corporate formalities matter.
Mixing operations, staff, and money across entities may seem convenient in the short term, but it creates chaos in disputes. Without clear separation, courts struggle to assign responsibility.
2. Successor-in-interest isn’t automatic.
Rolling assets into a new fund doesn’t guarantee the new entity inherits all the old fund’s rights. Proper legal steps aligned with jurisdictional law are critical.
3. Personal liability is real.
Even sophisticated traders aren’t shielded by corporate structures if they personally benefit from improper transfers. Courts will look through the paperwork to the underlying behavior.
4. Indemnification isn’t a get-out-of-jail card.
Contracts don’t protect managers accused of bad faith, and third-party claims require proving someone else was the true culprit.
5. Litigation drains resources.
Years of lawsuits, expert appointments, and escrow accounts froze over $13 million. Instead of growing in the market, that money sat idle while lawyers debated who it belonged to.
Why This Case Still Resonates
The hedge fund industry has only grown more complex since the early 2000s, with new structures, offshore entities, and evolving investor protections. Yet the core risks haven’t changed.
When partnerships fall apart, the combination of big money, high egos, and loose governance almost always ends in drawn-out litigation.
For hedge funds, investment firms, and even startups, the Stagg-Katcher dispute underscores a simple truth: build your business on clear rules, or risk years untangling the fallout.
The Connecticut District Court didn’t deliver a final, neat conclusion in 2011. Instead, it froze millions, demanded forensic accounting, and left the parties to fight it out.
In the end, the real takeaway isn’t just about who wins or loses in court. It’s about what could have been avoided.
A thriving hedge fund partnership dissolved not because the market turned against it, but because the partners failed to respect boundaries, governance, and transparency. That’s a lesson every business leader in finance or beyond should take to heart.
