2003 Sound Practices For Hedge Fund Managers

DAVID NISSENBAUM, a partner in the corporate department, specializes in investment management, private investment funds and banking regulation. LANCE FRIEDLER is an associate in the corporate department.

The Managed Funds Association ("MFA") recently published 2003 Sound Practices for Hedge Fund Managers (the "Sound Practices") which updates the sound practices that were published for the hedge fund industry in February 2000 in response to the President's Working Group on Financial Markets. (The Sound Practices is available on the MFA website, www.mfainfo.org.) The Sound Practices contain recommendations (the "Recommendations") which are intended to provide to investment managers of "Hedge Funds" ("Hedge Fund Managers") a framework for internal policies, practices and controls which will enhance Hedge Fund Managers' ability to manage their operations, satisfy their responsibilities to investors and address unexpected market events or losses. The Sound Practices is a resource for the hedge fund industry. Its timely republication comes in the midst of the industry continuing to experience strong growth, managers "institutionalizing" and regulators scrutinizing the industry. The Recommendations have been updated to address additional topics of recent concern to Hedge Fund Managers, including responsibilities to investors, valuation practices, business continuity and disaster recovery.

The MFA anticipates that the Recommendations will be further adapted and refined as the Hedge Fund industry and global financial markets continue to evolve. The recommendations are intended to be adapted in consideration of a manager's size and sophistication. While the Recommendations represent a possible "ideal" set of policies and practices that can serve as a benchmark for Hedge Funds and Hedge Fund Managers, they are not intended to be prescriptive requirements to be applied to all Hedge Fund Managers. Indeed, certain Recommendations may not be relevant or appropriate to every Hedge Fund or Hedge Fund Manager. They are also not intended to be a potential basis for governmental regulation or supervision, for auditing or examining the operations of Hedge Funds and Hedge Fund Managers or a substitute for professional legal, tax or accounting advice.

The Recommendations are divided into six major sections:

key management policies and internal controls;

responsibilities to investors;

sound valuation practices;

risk measurement and monitoring compliance with risk policies;

regulatory controls and compliance issues; and

business continuity and disaster recovery.

Most of the Recommendations are accompanied by a discussion of how the Recommendation may be implemented. In this article we highlight some of the Recommendations in each area. The Sound Practices also include detailed appendices on risk monitoring practices, U.S. regulatory filings and the MFA's "Preliminary Guidance" on developing anti-money laundering programs. Due to limitations on space, the appendices are beyond the scope of this article.

MANAGEMENT AND INTERNAL CONTROLS

(1) A Hedge Fund Manager should establish management policies and practices commensurate with the size, nature and complexity of the Hedge Fund Manager's trading activities and the Hedge Funds it manages.

(2) A Hedge Fund Manager should determine the investment, risk and trading policies to be observed with respect to each Hedge Fund it manages based on the specific investment objectives of the Hedge Fund.

(3) A Hedge Fund Manager should impose appropriate controls over its portfolio management and trading activities to ensure that these activities are...