After the metaphorical light bulb appeared above their heads, it took Integro's team two and a half years to develop the product they called Hedge Shield. Working closely with Amber Partners, an independent operational risk certification firm to the hedge fund industry, Integro this summer introduced coverage designed to protect hedge fund investors against losses resulting from a seizure of assets by regulators due to alleged or actual fraud.
Michael Klaschka, managing principal at Integro, said there's never been a product that was geared toward the institutional investor that promptly paid the loss to an investor as a result of a seizure by a governmental or regulatory agency based upon allegations of fraud. When a fund's assets were seized, investors were mainly helpless.
"The only recourse of the institutional investor is to go after any remaining assets of the fund, including any insurance proceeds, as well as the assets of the investment manager and general partner," said Klaschka.
"As you may know, everybody is going after that fund, and what the institutional investor had to do was get in line and wait three to five years to see if there were any remaining monies left after the fund was liquidated and everything was dispersed to creditors as well as the limited partners."
Keys to Hedge Shield are that the policy pays out within 90 days after a fund is seized in cases of alleged fraud and that there doesn't need to be a final adjudication or fact finding before there is a payout. The time factor is critical because proving whether or not fraud was committed can take three to five years. The crawling legal pace occurs as creditors and partners clamor for and sometimes squabble over any remaining assets.
But according to Klaschka, the piece of the product which could be responsible for the barrage of phone calls and e-mails since Integro anounced Hedge Shield on June 30, is the brokerage firm's collaboration with Amber Partners.
"One of the key elements to this product is the ability to access Amber Partners and their operational due diligence," he said. "In order to obtain the insurance, Amber Partners does a fraud due diligence check of every hedge fund in the institutional investor's portfolio. We think that is a major selling point of this product."
Reiko Nahum, founder and CEO of Amber Partners, said the company developed a methodology called Fraudcheck to assess the primary areas where the potential for fraud exists. The red flags that are reviewed include overstatement of the market value of a fund's assets, theft of fund assets, concealment of trades and claimed assets to which a fund does not have legal title.
Nahum said the Fraudcheck assessment, which begins after a new Hedge Shield client provides Integro with a schedule of their hedge fund investments, includes telephone interviews with the appropriate staff at the fund manager and administrator. The results of the assessment are supplied to the insurance carriers to assist in the underwriting process and are also passed on to the insured once coverage is bound.
Amber Partners' close relationship with the carriers makes Hedge Shield as much a risk management tool as it is an insurance product. The due diligence is extensive, with Amber acting in effect as an underwriter. Amber Partners' management has reviewed approximately 700 hedge fund operations across different types of firms, strategies and geographic locations, said Nahum.
"Underwriters have limited experience and knowledge on operational issues within the hedge fund industry," said Nahum.
Klaschka said a Hedge Shield client is going to have anywhere from $50 million to billions in assets under management in hedge funds, with an ideal candidate having an average hedge fund investment of $25 million to $50 million. That would include fund to funds, pension plans, endowments--primarily sophisticated investment structures.
The policy will pay up to the limit of liability within 90 days the last net asset valuation of the fund provided by an independent administrator. The NAV is calculated on a monthly basis, sometimes quarterly. If the fund received an NAV of, say, $10 per share the month before a seizure, Hedge Shield will pay the investor $10 per share times the number of shares owned, up to the limit of liability. The limit of liability is typically derived from the highest, or average, hedge fund investment an institutional investor may have.
"Hedge funds themselves may buy a fidelity bond or a general partnership liability policy, but that's for the hedge fund itself--it's not for the institutional investor," said Klaschka. "The investor really has no option. They invest in the fund to take investment risk. What they don't want to take is operational risk. We are transferring the operational risk of fraud to an insurance policy."
September 1, 2008
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