Cover offered for hedge fund fraud

When hedge fund manager and convicted fraudster Samuel Israel III disappeared this month, leaving nothing but the message “suicide is painless” scrawled in the dust on his car, you can be sure his life assurer did not pay out – not least because police believe he was trying to fake his death.

Another type of insurance policy might soon help investors caught up in scams such as the $400m Mr Israel sucked out of Bayou Management.

At the least, the new products being created should provide hedge fund investors with peace of mind amid widespread fear of fraud in the industry.

A second insurance product on Monday begins offering hedge fund investors cover for fraud losses, as Integro, a New York insurance broker, and Amber Partners, a risk rating agency for the industry, aim to capitalise on the fear of swindlers.

“While they [frauds] are not frequent within our industry, they occur enough that it causes investors to consider it seriously,” said Reiko Nahum, chief executive of Amber.

Investors appear to be keen: the first such product, launched in January by London start-up Protean, already covers $10bn of assets and Protean says it has another $20bn-$30bn of business in the pipeline.

Michael Klaschka, managing principal of Integro, said the tendency of regulators to freeze remaining assets upset investors already suffering from the fraud itself.

“Over the past two years we have spoken to dozens of institutions that have expressed frustration about their inability to get their capital back within five years in the case of a blow-up,” he said.

Integro covers only funds that have assets frozen by regulators, while Protean pay-outs can be triggered by other regulatory or legal action or referred to independent arbitration.

The problem for the insurance industry is a danger that investors who buy cover do not then carry out the expensive due diligence that most at present perform in to detect weak risk controls or potential fraudsters.

Ìnvestors might also choose to insure only funds that they fear might steal their money, making the risk to insurers far higher than simple fraud statistics on the $2,000bn-plus industry suggest.

Both Integro and Protean try to avoid these risks. Integro uses Amber to investigate each fund before agreeing insurance while Protean demands that clients have sufficient due diligence processes in place.

Both require investors to insure their entire portfolio, preventing them from insuring just the riskiest funds.

The cost to investors varies, with Protean charging 0.05-0.15 per cent of the value of the portfolio and Integro saying the cost should be less than 0.2 per cent, depending on the type of funds covered.

On the run
Whitecollar criminals in the spotlight

Samuel Israel was found guilty of defrauding investors in hedge fund Bayou Management out of more than $400m.

However, a manhunt began three weeks ago after the 48-year-old failed to report to a prison in Massachusetts to begin a 20-year sentence.

His car was found abandoned on the Bear Mountain bridge over the Hudson River in upstate New York.

Mr Israel was sentenced earlier this year after pleading guilty in September 2005 to conspiracy and fraud charges. Daniel Marino, Bayou’s former chief financial officer, also pleaded guilty to criminal charges and is serving a 20-year sentence at a federal prison in Arkansas.

Meanwhile, one of the earliest examples of a hedge fund hiding losses from investors by doctoring documents sent to investors and auditors led to Michael Berger being imprisoned.

He admitted hiding $400m of losses from investors in New York-based Manhattan Investment Fund.

However, he fled the US before sentencing in 2002 and was re-arrested in July last year while driving in Austria.

Mr Berger had concealed losses run up while shorting internet stocks and had been rumoured to be in the Dominican Republic.

He raised more than $575m for his hedge fund from wealthy individuals and big institutions, including Bank Austria, Credit Suisse and a Kuwait state fund, but lost $400m of it by betting against the internet bubble.