Steel Partners has been a formidable name in the hedge fund world in recent years. However, the activist fund now finds itself in a precarious position.

AsianInvestor has seen a copy of a State of Delaware legal filing that on January 13, 2009 was filed by Bank of America in its role as the master trustee of ACF Master Trust. The defendants include Steel Partners and Warren Lichtenstein, who manages the fund.

The legal pleading makes for uncomfortable reading. Steel Partners lost 43% of its assets in the first 11 months of 2008. As a result, 38% of investors asked to redeem.

Warren Lichtenstein then wrote to investors on New YearÆs Eve. Even though the fund had promised not to invest more than 25% in illiquids, the letter declared that its ôilliquid and in many cases control positions make it difficult and in some cases impossible to sell assets and businesses quicklyö.

The letter went on in a style described in the legal filing as, "part marketing gibberish and filled with what are meant to be motivational titbitsàquoting a rhymeàæLife is full of stumbling blocks or stepping stones. It all depends on which you choose, one you win and one you loseÆ.ö

So the investors found themselves well and truly on the other side of the looking glass. They were not getting their money back.

Furthermore, they were told their investment would be switched to an "ownership interest in a single company, which will soon become a reporting company under the Securities Exchange Act of 1934ö with the plan to list this entity on an exchange. This company, WebFinancial, would hold interests in various industrial concerns, namely, the old Steel Partners investments.

So, rather than their investment being correlated with the direct value of the investments, the investors will now have to find buyers for units in a Lichtenstein-controlled vehicle as their only potential exit. Lichtenstein says that the new arrangement ôwill not be a closed-end fundö (though presumably there isnÆt a long queue of people now waiting to invest with him). However, the plaintiff feel this reorganisation feels and smells exactly like a closed-end fund, and funds with these characteristics often trade at a discount to net asset value.

There may be no liquidity whatsoever in the new shares, and investors worry that Warren Lichtenstein might be the only buyer interested û at cents on the dollar.

The fund had originally charged a management fee of 1%-1.5% and a performance fee of 15% . To add insult to investor injury, under the new arrangement, the fees now go up to 2% and 20%.

The money is therefore locked up, fees have risen and there is no obligation to pay out any distributions. The investors reckon this has violated the express language of the fund documents and therefore the fund has been "fraudulently mismanaged", according to the Delaware legal filing.

So, the plaintiff wants a refund of his investment, or failing that, a receiver/custodian to manage the affairs of Steel Partners and WebFinancial, and also requests that the fees are cut.

This looks set to be a very important legal case in the hedge fund world. We approached Steel Partners to find out if any refutation was available, but at the time of writing they had not responded.