Screenshot of Burdford Capital's website.

The law community has had about a week to digest the accusations ping-ponging between Burford Capital and San Francisco-based investment firm Muddy Waters, and legal experts remain divided about the facts and impacts of the exchange. However, some argue the litigation funding industry might not look the same in the aftermath. 

Last week, Muddy Waters published a report calling Burford "arguably insolvent" and accused the litigation funder of manipulating its metrics for gauging financial returns. The next day, Burford issued a scathing rebuttal and hosted a lengthy shareholder call, slamming the report as false and misleading. On Sunday, Burford officially accused Muddy Waters of market manipulation. The Rosen Law Firm in New York is investigating the allegation on behalf of shareholders, and Freshfields Bruckhaus Deringer, Quinn Emanuel Urquhart & Sullivan and Morrison & Foerster are advising Burford.

The back-and-forth continued on Tuesday, with Muddy Waters ripping into Burford's response. 

"Leave it to former trial lawyers to talk so much, and yet say so little," Muddy Waters said in a statement. "BUR's written response and numbing two-hour call did nothing to dispel our view that BUR a) aggressively marks its cases up to generate non-cash profits, b) manipulates its … metrics in order to justify its fair value gains, c) deliberately confuses investors about the extent of its fair value gains in each period, and d) has a fragile balance sheet with too much leverage, particularly given the excessive costs the business runs (of which a significant portion could be management compensation)."

Muddy Waters did not stop there. The company also likened Burford to disgraced commodity traders Enron and Noble Group. 

"Moreover, we believe BUR is effectively sprinting on a treadmill whereby it is growing its portfolio aggressively not because there are so many great opportunities; but, rather because it has so aggressively taken fair value gains that sap the business of future earnings power, and it therefore needs to add litigation assets to the balance sheet in order to take more fair value gains. In this way, we also see BUR as possessing the same illness that, in our view, brought Enron and Noble Group down: addiction to mark-to-model gains financed by debt. BUR exhibits another characteristic of Enron and Noble Group – baselessly attacking critics in an attempt to distract investors from their own shortcomings."

To cap it off, Muddy Waters said the U.K.'s financial regulator, the Financial Conduct Authority, could have grounds to sanction Burford, and the company is standing by to work with the regulator. 

However, some litigation funding experts believe the report comes from a lack of understanding about a complicated industry.

Teddy Baldwin of Steptoe & Johnson in Washington, D.C., said the report reflects some misunderstandings of third-party funding. "As an example, I would not necessarily consider a case concluded after a judgment or an award when the claimant has a right to appeal," Baldwin said. "This is especially true with certain investor-state arbitration cases where the claimant can seek an annulment of the award."

Additionally, Baldwin said funders do not need to win every case to be profitable – or even half of them. "The business model is such that only a portion of the cases need to be won and judgments collected to be profitable," he said. "The growth of third-party funders is evidence of the potential profitability of third-party funding." 

However, the industry's growth could be one reason why Burford has had to rely on on about four cases for the bulk of its net realised returns during the last seven years, according to the Muddy Waters report.

In one of his previous papers, Jeremy Kidd, associate professor of law at Mercer University in Macon, Georgia, concluded that it was incorrect to think of litigation funding as leading to waves of new litigation. With likely a small increase in litigation, that would mean funders are moving in to an industry already dominated by lawyers and their contingency fees, Kidd said. "Competition between funders and lawyers would drive profits down, so I guess I'm not too surprised that profits aren't what were expected."

Luke Harrison of Debenhams Ottaway in St Albans, England, agrees that the litigation market has been devalued. "The Muddy Waters reports and the wide-ranging press coverage subsequent to it have probably poured some water on the litigation funding fire that has been raging, which has been attracting large numbers of investors," he said. "I think all it's done is cool down the hype around the litigation funding industry." 

Harrison said litigation funding is still a profitable asset class, but the issue highlights something that litigation funders have been well aware of: it's a risky business. Despite the well-known exposure, the lawyer suspects that it's more likely that regulators will descend on the industry after this altercation – even though the issues that have come to light might not be thoroughly dealt with via regulation. 

Lisa Rickard, president of the U.S. Chamber Institute for Legal Reform, an outspoken opponent of many litigation funding practices, agrees that regulators are now paying attention.

"These developments underscore our long-held view that the third-party litigation funding industry needs greater oversight and transparency," Rickard said. "Both Congress and the federal judiciary are scrutinising the industry, and regulators at every level should take action in order to protect litigants and innocent investors."