Hedge Funds’ Lawsuit Risk Rises After Galleon Probe

Hedge funds’ risk of lawsuits is rising after regulatory probes of insider trading at Galleon Group LLC and the collapse of MF Global Holdings Ltd., insurance rates show.

Insurers are quoting rates that are 5 percent to 10 percent higher for coverage that protects hedge funds against government investigations and investor lawsuits, after more than two years of rate declines, according to an e-mailed statement today from SKCG Group, a White Plains, New York-based insurance broker.

Hartford Financial Services Group Inc. (HIG), Chubb Corp. (CB) and XL Group Plc (XL) are among insurers that write the policies, according to Richard Canter, SKCG’s president and chief operating officer. A hedge fund with $200 million in assets under management seeking $5 million of coverage could expect to pay about $75,000 annually, up from less than $70,000 six months ago, he said. That compares with about $125,000 in late 2009.

“Insurance companies want to get back to that level,” Canter, whose firm serves about 160 hedge funds worldwide, said in a phone interview today. “The aggressiveness of the regulators” is driving prices higher, he said.

Property and casualty insurers are raising rates after natural disaster losses last year hurt underwriting results and near record-low bond yields pressured investment income. Regulators have stepped up enforcement actions against asset managers, leading some carriers to project higher claims costs from professional-liability lawsuits. After the 2008 credit crisis, more insurers entered the market, increasing supply and driving down prices, Canter said.

‘Much Worse’

“The insurance industry thinks this is going to get much worse, not better,” Richard Maloy Jr., chief executive officer of insurance broker Maloy Risk Services Inc., said in a phone interview last week. “You’re going to see way more investigations” and insurers expect they’ll incur the cost.

Professional liability coverage in general pays a hedge fund’s legal expenses if employees are the subject of a regulatory probe or legal action by the government or investors. The policies are triggered once allegations are made, and before fault has been determined. Insurers can deny or try to claw back claims payments if policy terms are violated. Most hedge funds allocate the cost of coverage to investors, said SKCG’s Canter.

Chubb raised renewal rates for professional liability coverage in the U.S. in the fourth quarter, the first increase since 2009, the Warren, New Jersey-based insurer said on a conference call in January. Policies that indemnify crime allegations hurt underwriting results in 2011.

Insider Trading

The Galleon probe, which leveraged the widespread use of FBI wiretaps for the first time in an insider-trading investigation, led to convictions of more than two dozen people, including the firm’s co-founder Raj Rajaratnam. Former Goldman Sachs Group Inc. director Rajat Gupta was charged in October with passing nonpublic information to the hedge fund manager. Rajaratnam has appealed his May 11 conviction, and Gupta has denied wrongdoing.

MF Global, the broker-dealer run by former Goldman Sachs Co-chairman John Corzine, filed for bankruptcy Oct. 31 after a $6.3 billion bet on the bonds of some of Europe’s most indebted nations prompted regulator concerns and a credit downgrade. Government investigators have been analyzing events prior to firm’s collapse, when as much as $1.6 billion in client funds went missing, according to a person with knowledge of the probes, who isn’t authorized to speak publicly on the matter.

MF Global

Corzine and other executives face at least two potential class actions over the collapse. Futures customers of MF Global Inc. have been competing to lead a lawsuit over the alleged theft of $1.2 billion of their assets. An investor suit led by the Virginia Retirement System alleges that Corzine made misleading statements that inflated the prices of MF Global securities.

MF Global’s insurance unit issued $190 million of liability policies for Corzine, other professionals and the company through May to cover costs of defending against allegations of wrongdoing, Louis Freeh, the trustee for the parent company, said in a Feb. 3 court filing in Manhattan. The policies don’t belong to the bankrupt estate and the coverage should be continued, said Freeh, a former director of the Federal Bureau of Investigation.

To contact the reporter on this story: Noah Buhayar in New York at nbuhayar@bloomberg.net.

To contact the editor responsible for this story: Dan Kraut at dkraut2@bloomberg.net

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