Trade errors can cause substantial harm to hedge fund managers and their investors. Such errors can, among other adverse consequences, undermine investors’ confidence in a manager’s trade execution capability; cause a manager to miss investment opportunities; and divert investment and operating resources in the course of correcting errors. As such, managers, investors and regulators are theoretically aligned in their shared interest in avoiding trade errors. As a practical matter, however, there is no regulatory roadmap to best practices for trade error prevention, detection and remediation. SEC guidance has been sparse on this topic; and industry practice has largely filled the vacuum left by the dearth of authority. Accordingly, in the area of trade errors (as in other areas, such as principal transactions
), hedge fund managers are left to divine industry practice – and, further, to conform relevant practice to the specifics of their businesses. How can hedge fund managers do this? To begin to answer this hard and multifaceted question, the Hedge Fund Law Report has been publishing a three-part series on preventing, detecting, resolving and documenting trade errors. This third installment in the series discusses the 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. The first article in the series discussed the challenge of defining a trade error; a manager’s legal obligations relating to the handling of trade errors; and the policies and procedures that managers should consider to prevent, detect, resolve and document trade errors. See “How Should Hedge Fund Managers Approach the Identification, Prevention, Detection, Handling and Correction of Trade Errors? (Part One of Three)
,” Hedge Fund Law Report, Vol. 6, No. 10 (Mar. 7, 2013). The second article in the series outlined various measures to prevent trade errors; detect trade errors after execution; report trade errors once identified; resolve trade errors; and calculate losses resulting from trade errors. See “How Should Hedge Fund Managers Approach the Identification, Prevention, Detection, Handling and Correction of Trade Errors? (Part Two of Three)
,” Hedge Fund Law Report, Vol. 6, No. 11 (Mar. 14, 2013).