Regulatory obligations, trading compliance, and risk monitoring for hedge fund managers
Compliance in hedge funds operates within a regulatory framework that has expanded significantly since the financial crisis. Most hedge fund managers of meaningful size now register with the SEC as investment advisers, subjecting them to the Investment Advisers Act and its associated rules. Even smaller managers often face registration requirements at the state level or through CFTC registration if they trade futures or swaps. The compliance function must navigate these overlapping regimes while supporting the trading activities that drive fund performance.
SEC registration as an investment adviser triggers numerous ongoing obligations. Registered advisers must maintain a comprehensive compliance program, designate a Chief Compliance Officer, and conduct annual compliance reviews. The compliance manual must address the specific risks relevant to the adviser's business, which for hedge funds typically includes trading practices, valuation procedures, and investor communications.
Form ADV, the investment adviser registration document, requires disclosure of business practices, fee structures, disciplinary history, and potential conflicts of interest. Part 2A, the narrative brochure, must be delivered to clients and updated annually. Part 2B covers supervised persons, while Form CRS applies to advisers serving retail investors. Maintaining accurate and current Form ADV filings represents an ongoing compliance responsibility.
The intensity of hedge fund trading activity creates substantial compliance requirements around trade execution and allocation. Best execution obligations require advisers to seek the most favorable terms reasonably available for client transactions, considering factors beyond just price, such as execution speed, likelihood of execution, and settlement capabilities.
Trade allocation policies govern how investment opportunities are distributed across funds and accounts. When a manager operates multiple funds or separately managed accounts, allocation procedures must be fair and disclosed to investors. The compliance function monitors allocation practices to ensure consistency with stated policies.
Soft dollar arrangements, where commission dollars pay for research and brokerage services, require compliance oversight. Section 28(e) of the Securities Exchange Act provides a safe harbor for soft dollar usage, but only for qualifying research and brokerage services. Compliance must review soft dollar arrangements, ensure products and services qualify under the safe harbor, and maintain appropriate documentation.
Registered investment advisers must adopt a code of ethics that establishes standards of conduct for supervised persons. For hedge funds, this typically includes personal trading policies that address potential conflicts between employee trading and fund positions.
Access persons—those with access to nonpublic information about fund trading or recommendations—generally must report personal securities holdings and transactions. Pre-clearance requirements may apply to certain trades, and restricted lists may prohibit trading in securities the fund is actively trading or considering. The compliance function administers these programs and reviews reports for potential violations.
Hedge funds that invest in public securities face heightened insider trading risks. The compliance function must establish policies and procedures to prevent the misuse of material nonpublic information. This includes information barriers between research and trading when appropriate, expert network usage policies, and monitoring of unusual trading patterns.
Training programs should educate investment professionals on insider trading prohibitions and the grey areas that can arise in securities research. When the fund receives potentially material information, compliance should be consulted before trading decisions are made.
Large hedge fund advisers file Form PF with the SEC, providing data about fund size, leverage, counterparty exposures, and investment positions. The reporting thresholds and frequency depend on assets under management. Large hedge fund advisers (those with at least $1.5 billion in hedge fund assets) file quarterly with more detailed information than smaller filers.
Form PF data supports the Financial Stability Oversight Council's systemic risk monitoring. Compliance must ensure accurate and timely filings, which requires coordination with the CFO and operations team to gather the necessary data.
The SEC's Marketing Rule, which replaced the prior advertising and cash solicitation rules, governs how advisers may advertise their services and use testimonials and endorsements. For hedge funds, this affects how performance can be presented, what disclosures must accompany track records, and how third-party marketers may be compensated and disclosed.
Compliance reviews all marketing materials before use, ensuring performance presentations meet rule requirements, hypothetical performance is appropriately limited and disclosed, and third-party ratings are properly substantiated.