Some while ago we touched on the topic of "prospectus creep", or the habit of hedge fund lawyers to gradually add new clauses, exclusions and indemnifications to hedge fund offering documents.
"There appears to be no common understanding among hedge fund managers on whether trading errors should be borne by the fund manager or the fund. We think that the hedge fund manger, as a matter of law, must bear the costs of any errors for which it is responsible, in dealing with fund assets. To not do so would not only cause reputational damage but could also have regulatory or legal consequences."
The FSA must have changed their mind, because this policy no longer seems to apply. The change is to specifically include trade errors within the scope of activities for which the investment manager is indemnified under the terms of the investment management agreement. In these agreements, the manager is indemnified against losses arising from anything and everything except gross negligence, willful default and fraud (as an aside, the latest trend is to try and exclude even the words "gross negligence", but that is a topic for another day.)
Our friendly hedge fund lawyers now seek to define trade errors as run of the mill, unavoidable hazards of running an asset management business. We have seen an increasing trend for offering documents to note that items such as reconciliation errors, "fat finger" errors, inaccurate recording of corporate actions, errors related to margin requirements, other accounting and profit and loss reporting mistakes - and of course trade errors themselves - do not constitute gross negligence. One well known hedge fund law firm even likes to add the helpful phrase "and shareholders should assume that such errors will occur."
In most areas of business, if you make a mistake, you pay for it. This all leaves us very puzzled as to why hedge fund lawyers believe that the rules of commerce don't need to apply to fund offering documents.
Which leads us to our final point, which is the particular irony. All this legal brainpower does not come cheap: it is expensive to think of new ways to constantly tighten hedge fund terms and conditions. Who pays the legal bills for drafting new offering documents with ever more restrictive terms?
It's the investors, of course, as legal bills are charged to the fund, not paid by the manager.