How Should Hedge Fund Managers Approach the Identification, Prevention, Detection, Handling and Correction of Trade Errors? (Part One of Three)

Trade errors can paralyze even the most seasoned hedge fund managers, both because of the potential magnitude of the financial losses, and because of the urgency with which such errors must be addressed and resolved.  As a result, it is imperative that hedge fund managers adopt a plan as well as policies and procedures designed to prevent, detect, quickly resolve and document trade errors.  Unfortunately, regulatory guidance concerning the handling of trade errors is scant, and hedge fund managers have been challenged to formulate their own measures for addressing trade error issues.  With this in mind, the Hedge Fund Law Report is publishing this three-part series designed to assist hedge fund managers in navigating the myriad legal, investment and operational challenges posed by trade errors.  This first installment discusses the challenge of defining a trade error; a manager’s legal obligations relating to the handling of trade errors; and policies and procedures that managers should implement to prevent, detect, resolve and document trade errors.  The second installment in this series will outline specific strategies to prevent trade errors; detect trade errors after trade execution; report trade errors once identified; resolve trade errors; and calculate losses resulting from trade errors.  The third installment in this series will discuss allocation of losses and gains resulting from trade errors among a manager and its clients; limitations on the allocation of trade error losses; documentation of trade errors; whether managers can obtain insurance to cover losses resulting from trade errors; and common mistakes managers make in handling trade errors.

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