A couple of startling trends have emerged over the last few years, which demonstrate a significant increase in the number of lawsuits brought against hedge fund managers and their directors and officers, and an increase in the dollar amount necessary to settle these lawsuits. Just a few years ago, only a few of the largest hedge funds purchased management liability insurance. Now, according to The Chubb Group of Insurance Companies, at least 50% of the top 25 hedge funds carry a management liability policy.
The increase in lawsuits against hedge fund managers and their general partners, officers, and directors, may have resulted from recent news of substantial losses at high profile hedge funds, an unsettled regulatory environment, and an influx of new investors who are not adverse to litigation. Currently, the three most common types of potential plaintiffs are hedge fund investors, the companies that hedge funds invest in, and government regulators.
Although a hedge fund manager may be sued for a number of reasons (e.g., mismanaging fund assets, misrepresenting a fund’s performance, and failing to properly disclose the risks of an investment in a fund), the fund will generally indemnify the hedge fund manager from such liability. However, defending a lawsuit can be expensive and the strain on the fund’s assets may adversely affect the fund’s ability to achieve its investment objectives. One possible solution for hedge fund managers is to purchase some form of management liability insurance.
Most insurance companies try to get hedge fund managers to purchase a bundle of policies, which are grouped under the broad heading of Management Liability Insurance. The policies that typically make up this group include:
- Directors and Officers Liability Coverage,
- Partnership/LLC Liability Coverage,
- Non-Indemnifiable D&O/GP Coverage,
- Investment Adviser Professional Coverage,
- Employment Practices Coverage,
- Fiduciary Liability Coverage, and
- Errors and Omissions Liability Coverage.
The purpose of these policies is to provide coverage for all potential liability and provide a hedge fund manager with sufficient funds to defend a lawsuit and pay for a potential settlement. Comprehensive coverage can cost between $75,000 and $200,000 per year to buy $5,000,000 worth of insurance with a $150,000 deductible. The actual insurance limit and deductible will depend on an assessment of a particular hedge fund manager’s likely risk of a lawsuit, its tolerance for risk, its internal control controls, and what the insurance market is willing to provide.
Although hedge fund managers are not required to purchase management liability insurance, a thorough cost-benefit and risk analysis should be performed by most hedge fund managers with significant assets given the current state of the industry.
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