* XL suit claims Level Global's legal fees aren't covered
* Judge says XL must pay claims while suit is pending
* Discovery documents in hundreds of millions for Chiasson trial
NEW YORK, May 10 (Reuters) - A federal judge said during a court hearing in New York on Thursday he is prepared to order an insurance company to keep paying the legal fees of several former hedge fund managers and traders caught up in an insider trading investigation.
U.S. District Court Judge Paul Engelmayer said irreparable harm could be done to the employees of Level Global Investors, if XL Speciality Insurance did not keep paying legal fees for their defense.
But the judge said he would give XL enough time to appeal his decision if the insurer wanted.
In March, XL sued Level Global, claiming it did not have to pay the attorney fees for employees implicated in the insider trading ring because a former analyst for the now-closed hedge fund had been secretly cooperating with federal authorities.
XL filed the suit after U.S. prosecutors in Manhattan unsealed a guilty plea by Level Global analyst Spyridon Adondakis, who had begun cooperating with investigators on an inquiry that led to charges in January against the hedge fund's co-founder Anthony Chiasson.
Chiasson and employees of four other hedge funds have been described by prosecutors as a group of friends - seven in all -who formed a criminal club, passing around inside tips on Dell Inc.. and reaping a $62 million profit.
The Federal Bureau of Investigation raided Level Global's office last year. Defense lawyers said the fund continues to exist only for the purposes of engaging in the legal matters surrounding Chiasson's case.
"Operating deficit is running in the millions of dollars," said James Sottile, a partner at Zuckerman Spaeder in New York, who is representing Level Global, at the hearing.
FRAUD VOIDS COVERAGE, XL SAYS
XL is arguing that since the cooperating witness, Adondakis, knew he had committed fraud at the time the insurance policy was signed, any charges stemming from or related to his crime aren't covered by the policy.
Level Global lawyers argue that the fund's general counsel, who signed the policy application, didn't know about the crime and did not learn of it after making a reasonable inquiry among Level Global's employees into possible facts or circumstances that could lead to charges.
They also argue that since the fees XL has been paying are not for Adondakis himself, and only Adondakis is actually a convicted criminal, the exemption shouldn't apply.
As part of its policy, XL agreed to cover $10 million in claims for Level Global. It has paid out all but $2.7 million in claims so far, and Level Global spent an amount equivalent to the remaining balance before it received word of XL's suit.
The fight between Level Global and XL isn't over. Thursday's hearing wasn't designed to produce a decision on who is right about the policy; the two sides merely argued about whether XL should pay Level Global's legal fees in the meantime, as XL's lawsuit progresses.
The case is XL Specialty Insurance Company v. Level Global Investors, L.P., et al U.S. District Court, Southern District of New York, No. 1:12-cv-01598-PAE.