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Indemnification and Insurance

From time to time, independent directors are individually named as defendants in fund industry lawsuits. At other times, independent directors, while not named, are the target of discovery efforts and depositions. Independent directors may also become involved in regulatory investigations or regulatory proceedings. Attempts to reduce the direct financial impact of such fund-related actions commonly focus on arranging for appropriate indemnification of independent directors and adequate professional liability insurance coverage for any financial exposure.

Indemnification

Indemnification allows independent directors to be reimbursed from fund assets for liabilities (including legal expenses) incurred by them as defendants or witnesses in fund-related actions. Indemnification also allows independent directors to receive “advances” to cover their legal and associated expenses, as those expenses are incurred during the course of an action. Because funds typically have minimal risk of insolvency, indemnification generally affords strong protection to fund independent directors.

Insurance

Directors and Officers (D&O) insurance affords a second line of protection against the direct financial impact of fund-related actions. While there is no legal requirement that they do so, most funds arrange to purchase such insurance. D&O insurance typically provides coverage for liabilities, including legal expenses, resulting from negligence or breach of duty by fund directors or officers in performance of their duties (though not for liabilities resulting from their fraud, dishonesty, or similar misconduct). As with indemnification, D&O insurance typically allows independent directors to receive “advances” to cover their legal and associated expenses, as those expenses are incurred by them during the course of a fund-related action. Unlike indemnification, liabilities and advancements covered by D&O insurance are paid by the insurer, rather than directly out of the fund’s assets.

Some funds purchase a third line of protection, commonly referred to as independent directors liability (IDL) insurance. IDL insurance mitigates the exposure of fund independent directors to various risks associated with indemnification and D&O insurance.

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