Josh Barbanel and Steve Eder (online.wsj.com)

A judge’s ruling in the battle between three Louisiana pension funds and New York hedge-fund firm Fletcher Asset Management shows the difficulties the funds may face in recovering their investments.

After the three pension funds sued to recover investments in the Fletcher fund—which had been pitched to them as offering a 12% minimum annual return—Fletcher gave the pension funds stock rights that the judge has called “commercially worthless.”

In a written decision released this past week, the Cayman Islands judge found that to secure the value Fletcher put on the investment, the pension funds would need to put up an additional $65 million and prevail in a lawsuit against a Georgia bank.

The judge this month ordered the “winding up” of the hedge fund by court-appointed liquidators at Ernst & Young. The pension funds in January had petitioned the court for a liquidation, saying they weren’t able to withdraw their money from the hedge fund. One Cayman-based lawyer not involved with the matter said such a petition is typically a last-resort measure for investors seeking recourse from a hedge fund

On Friday, a spokesman for the Fletcher firm said it intended to file a notice of appeal soon. It said it believed the court’s conclusion and its rulings were “incorrect.”

The ruling said that in February, two weeks after the pension funds filed suit, Fletcher turned over ownership of the stock rights in an effort to pay nearly all of the $144.5 million in redemptions the pension funds sought. The rights, in United Community Banks Inc., a small bank-holding company based in Blairsville, Ga., were valued by Fletcher at $136.1 million when they were transferred, based on a valuation by a Fletcher consultant, the decision said. The pension funds were given the right to buy preferred shares for $65 million that were convertible to common shares at a set price. At the time of the purchase, the funds would get warrants to buy more shares at another specified price. The ruling rejected the valuation set by Fletcher. It said that the bank had reset the conversion price after the bank brought in more investors and implemented a reverse stock split last year, making the rights far less valuable than Fletcher asserted. To get the higher valuation, the rights owners would have to go to court and successfully challenge the bank’s pricing, said the ruling. The Fletcher firm told the court it would pay for the litigation, the ruling said.

“Those ‘assets’ as discussed above are virtually worthless,” without the immediate payment of $65 million to exercise the stock rights, said Judge Anthony Smellie, chief justice of the Grand Court of the Cayman Islands. “And even then would be of doubtful advisability as an investment.” The bank had said publicly the reverse stock split changed the conversion price of the preferred from $5.25 a share to $26.25. With the stock now trading at about $9.50 a share, the warrants and the conversion value of the preferred stock are both deeply under water.