The class action against LightSquared's Falcone

Investors who claim Philip Falcone wrongfully burned through $3.4 billion of their money for his wireless telecommunications startup LightSquared LLC may find it tough to prove that the hedge fund manager changed his spots and owes them a refund.

The picture painted by Lili Schad, the lead plaintiff in the putative class action against Falcone, is one of a hedge fund manager taking advantage of his investing prowess to bamboozle wealthy, but not necessarily ultra-sophisticated investors, into coming on board to one enterprise, only to find out that he used their money for something entirely different.

Schad, for example, is a documentary filmmaker whose movies often celebrate the outdoor life. Her father, Robert, founded Husky Injection Molding Systems.

But Falcone's investment in bankrupt SkyTerra Communications Inc.'s wireless spectrum, which he then used to start up LightSquared, could be construed as the kind of distressed investing that investors were in for when they signed on with his hedge fund, Harbinger Capital Partners LLC.

Starting in 2007, Falcone raised more than $20 billion for his new fund, mostly from family offices and wealthy individuals, rather than institutional investors, like banks or pension funds, according to a person with knowledge of the fund.

Schad claims she invested $4 million in Falcone's fund with the understanding that he would invest in distressed investments; not unlike the subprime mortgages that Falcone was famous for betting against.

That is the main tipoff to one of the main problems investors will face in litigating their lawsuit.

Eric Lewis, of Lewis Baach PLLC, says the courts, especially in the federal system, scrutinize the offering documents to see how much discretion the manager has in how he invests money.

"Does it look like an investment manager who made a material change to the strategy," Lewis says. "Or does it look like an investor who took the big gains when they came in and now are shocked to find out they are losing 18%?"

After all, a lot of investors got very wealthy in 2007 following Falcone in his bet against the subprime mortgage debacle.

In the LightSquared case, however, Jacob Zamansky, of Zamansky & Associates, one of Schad's lead attorneys, says the fund's strategy changed materially when Falcone went "all in" on his wireless network dream.

Falcone knew, as early as 2002, that he would be up against the makers of GPS systems, which complained that LightSquared's technology would interfere with theirs, Zamansky claims.

LightSquared lost that fight last week when the Federal Communications Commission withdrew its support for a waiver necessary for the system to operate.

A spokesman for Harbinger Capital says that the suit is without merit and would be vigorously contested.

One of the few institutional investors in the Harbinger fund was Goldman, Sachs & Co. But Goldman, being ... well ... Goldman, got its $50 million out in 2009, while other investors weren't allowed to withdraw their funds. The Securities and Exchange Commission has started an inquiry into that situation.

Goldman Sachs has, in the past, refused to comment on its Harbinger investment.

For those investors who couldn't get out, the fund was down 3.44% in November and down 13.49% year-to-date, and had shrunk to assets under management of $5.7 billion, the lawsuit alleges.

Of that $5.7 billion, 60% was sunk into LightSquared, and Harbinger reportedly marked down his investment 50%.