Watch out for that hedge fund sucker punch!
by Ali Chaudhry

Sylvester Stallone, Julia Roberts, John Cusack, it sounds more like a list of the rich and famous in Hollywood, but in fact all these individuals have been victims of hedge fund fraud in the last decade.

Sly for example was taken to court in 2006 to return the $1.3 million profit he made out of his investment in Lipper Convertibles despite his lack of knowledge of the actual fraud. The problem, investigations later revealed, was that the Lipper portfolio manager had inflated profits by at least 40 percent, meaning the fund never made that money!

Such cases highlight the risks inherent in investing in hedge funds, despite the attractive returns they often yield, which typically outperform equity markets. Over the last few years, risks associated with fraud and redemption have become increasingly concerning.

Risks can be classified into three areas:

• The risk of fraud from within the organisation
• The risk of sustaining a direct financial loss due to fraud within a third party investment manager or fund
• Costs associated with a fraudulent conveyance claim brought against an investor after an investment has been withdrawn from a fund

The Bayou case in 2005 for example proved that due diligence, however thorough, can never identify or prevent all the fraud risks associated with an investment. Thankfully for investors, to complement the due diligence by investors, investors can now secure added protection by purchasing an Institutional Investor Protection Bond.

This product offered by JLT Asia addresses the following risks:

This provides broad crime coverage and protects the insured against a fraud within the company, perpetrated by an employee with the intent to obtain improper financial gain or intent to cause the insured to sustain a loss.

This provides protection in the event that the insured sustains a direct financial loss caused by fraud within a third party fund in which they have invested. Cover is provided when a third party employee commits a fraud or theft with the intent to achieve an improper personal gain or cause the insured to sustain a loss.

This section provides defence costs cover for the insured against a redeemed investor/fraudulent conveyance suit arising out of a fraud within a fund in which the insured had invested. Insurers will provide coverage if the insured is targeted by defrauded investors or a bankruptcy trustee of a fund asking the insured to pay back the redeemed investment.

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