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Scott Sacane's days as manager of Durus Capital Management might be numbered, following an unusual display of shareholder activism in the loosely regulated hedge fund industry.

A group of Durus investors, at a meeting last Thursday in the Cayman Islands, ousted the board of one of the hedge fund's main investment funds and replaced it with three handpicked directors, people familiar with the situation said. The new directors also extended a freeze on redemptions at Durus.

According to these people, the shareholder meeting was organized after the former board rejected calls from the investor group to resign in the wake of Durus' unusual trading activity in two small health care stocks:

Esperion Therapeutics

(ESPR) - Get Esperion Therapeutics, Inc. Report

and

Aksys

(AKSY)

. The old board was ousted in a unanimous shareholder vote on Sept. 4.

Neither Sacane's attorney nor his publicist were available for comment. But several attorneys who specialize in advising hedge funds said the action by Durus investors is not a vote of confidence in Sacane's management skills.

The Outcry

"Given the fact the board of directors has been replaced by the shareholders, there would appear to be very little trust between the shareholders and the investment manager," said Ron Geffner, a partner with Sadis & Goldberg. "It's not a good sign."

The investor uprising at Durus comes at a dicey time for Sacane, whose unusual trading activity in Esperion and Aksys is being investigated by the Boston office of the

Securities and Exchange Commission

.

Sacane claims his $400 million hedge fund "inadvertently" acquired huge equity stakes in Esperion and Aksys over the past year, but realized it only this summer. He disclosed recently that roughly 70% of his 2-year-old hedge fund's assets are tied up in those two small stocks.

Durus investors are in a bind because Sacane was forced to sign agreements with Esperion and Aksys that bars the hedge fund from selling any shares until the end of the year. That means Durus can't do much trading without liquidating its holdings in a smattering of other health care stocks, including

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Allos Therapeutics

( ALTH) and

Novoste

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. Indeed, that's something Sacane has begun doing, according to recent regulatory filings.

Aspern Papers

The problems at Durus also are complicated by the fact that both companies are suing Sacane and Durus under a securities regulation that prohibits an investor from generating short-term trading profits in a stock in which he holds a big stake. The lawsuits, filed in a federal court in Connecticut, where Durus is headquartered, seeks to force Durus to cough up millions of dollars in trading profits.

In an earlier article,

TheStreet.com

estimated that in July, Durus generated proceeds of $25 million from selling part of its Esperion holding (it also did some buying in Esperion in that period and its profit or loss on the sales aren't known).

At last count, Durus owned a 29% stake in Esperion and a 77% stake in Aksys.

In early August, Sacane and the old board tried to minimize the scandal's impact and prevent investors from bailing on the hedge fund by indefinitely freezing all investor redemption requests. In the event of a cash crunch, hedge fund managers usually have the power to prevent investors from pulling their money out of a fund. The newly elected board has opted to continue that freeze.

A source familiar with the Durus matter said the investor group that ousted the old board wanted to have a bigger say in how Durus' affairs are managed going forward.

The investor group and the new board, for instance, are taking a leading role in trying to negotiate settlements in the litigation with Esperion and Aksys. Esperion Chief Financial Officer Timothy Mayleben said he had met recently with representatives for the investor group, which is represented by the big New York law firm Schulte Roth & Zabel, to discuss a possible settlement.

The Two Magics

But the board's ouster doesn't necessarily mean the investors will move to replace Sacane as Durus' manager. Mayleben said he's been told the investor group "continues to support" Sacane.

Indeed, even with the new board, Sacane still has considerable clout at Durus. The board oversees only the affairs of Durus' offshore investment fund, which is incorporated in the Cayman Islands. Sacane remains the managing partner of Durus' domestic investment fund.

It's not uncommon for hedge funds to have both domestic and offshore investment vehicles. In most hedge funds, the domestic fund is organized as a limited partnership and led by the hedge fund manager. Meanwhile, the offshore fund is run by a board, which is advised by the same hedge fund manager. Investors seeking to avoid, or minimize, paying federal taxes, tend to flock to offshore funds.

In theory, there is supposed to be an arm's length relationship between the board of an offshore fund and the hedge fund manager. But in practice, offshore boards tend to be a rubber stamp for a hedge fund manager.

Offshore boards are typically filled with so-called "professional directors": lawyers, accountants and retired business executives living in the Cayman Islands and other tax havens, who make a living by serving on hedge fund boards. And sources said that was the case with the original board of Durus' offshore fund.

It's unusual for investors in an offshore fund to band together and put their own board members in charge. If nothing else, it means Sacane must now work with a more activist board and no longer will have a free hand to buy and sell as he pleased, as he did before.