A $200 million 5 year old hedge fund has posted 2 consecutive quarters of negative returns and just announced a 3 rd quarter loss of 25%. Even though cumulative returns since inception are +18%, due to the difficulties of the current year, new investors are displeased with expectations not being realized.

Unexpectedly, an investor in the Fund files a lawsuit against the Fund (Partnership or LLC), the General Partner/Managing Member, Advisor and the Directors & Officers alleging misrepresentation, fraud, securities law violations and fund prospectus violations.

The demand for damages is $5,000,000.

Subject to the terms, conditions and exclusions of the policy, comprehensive coverage including Error and Omissions for the Fund, GP & Advisor (entities) and Directors & Officers for the natural person managers (individuals) generally responds to these allegations made against the various entities and individuals in their respective capacities.

The absence of coverage inclusive of all entities will otherwise require the loss adjustment process to allocate a percentage of liability that relates to the total damages sought, to each of the alleged parties, both covered and uncovered. This allocation process is essentially an assignment of liability per defendant, which would restrict the amount of indemnification made available under the policy to only those parties for whom coverage was in fact provided.

Following further discovery regarding the involvement of each of the defendants in the matters alleged, it was determined that all contributed equally and as such the allocation of liability as it relates to the total damages sought was 25% to each the Fund, General Partner, Adviser and D&O’s.

Clearly, the application of this allocation formula to less than 100% of covered entities, creates potential for significantly less coverage than what might otherwise be available had coverage been provided to all entities.

Given the complex organization structures within which most Hedge Funds operate, the potential for liability extends well beyond the Directors & Officers.

A broad based insurance program including coverage for the Fund and the legal entities affiliated therewith, offers the best solution to closing structural gaps allocation might otherwise create in policies which do not comprehensively address all potential entities and individuals from whom liability might so be alleged.

I encourage anyone that is interested in our specialized insurance products for Hedge Funds to contact me directly.

Fred Gaston, CPCU
Contact Fred Gaston
1.914.864.1168