BEST PRACTICES 

FOR THE 

HEDGE FUND INDUSTRY 

~ ~ ~ ~ ~ 

REPORT 

OF THE 

ASSET MANAGERS’ COMMITTEE 

TO THE PRESIDENT’S WORKING GROUP

ON FINANCIAL MARKETS

January 15, 2009 
* * * 

THE ASSET MANAGERS’ COMMITTEE

Eric Mindich, Chair (Eton Park Capital Management) 

Anne Casscells (Aetos Capital, LLC) 

Marc Lasry (Avenue Capital Group) 

William Von Mueffling (Cantillon Capital Management) 

Anne Dinning (D. E. Shaw & Co., L.P.) 

Jonathon S. Jacobson (Highfields Capital Management) 

James S. Chanos (Kynikos Associates LP) 

Daniel S. Och (Och-Ziff Capital Management) 

Daniel H. Stern (Reservoir Capital Group) 

Edward Mulé (Silver Point Capital, L.P.) 

COUNSEL TO THE ASSET MANAGERS’ COMMITTEE

Sullivan & Cromwell LLP 

Schulte Roth & Zabel LLP 

* * * 
Table of Contents

 i 

EXECUTIVE SUMMARY ............................................................................................... i

BEST PRACTICES ...........................................................................................................1

Disclosure and Investor Protection ..................................................................................1

I. Disclosure of Material Information to Investors...................................................1 

II. Ongoing Information Provided to Investors..........................................................5 

III. Side Letters and Parallel Managed Accounts......................................................10 

A. Side Letters....................................................................................................10 

B. Parallel Managed Accounts...........................................................................11 

IV. Participation of Investors ....................................................................................11 

V. Disclosure to Counterparties ...............................................................................12 

Valuation...........................................................................................................................14

I. The Valuation Committee ...................................................................................14 

II. Implementation of Valuation Policies.................................................................17 

III. Valuation Policies and Procedures......................................................................17 

A. Baseline Elements of the Valuation Policy...................................................18 

B. Investment Positions with No Readily Ascertainable Market Value............20 

C. Side Pockets and Other Similar Arrangements.............................................20 

Risk Management ............................................................................................................22

I. The Manager’s Approach to Risk Management .................................................22 

A. Identification and Design ..............................................................................22 

B. Measurement, Monitoring and Management ................................................23 

C. Personnel .......................................................................................................24 

II. Categories of Risk ...............................................................................................25 

A. Liquidity Risk................................................................................................25 

B. Leverage Risk................................................................................................26 

C. Market Risk...................................................................................................27 

D. Counterparty Credit Risk ..............................................................................30 

E. Operational Risk............................................................................................31 

Trading and Business Operations ..................................................................................33

I. Counterparties .....................................................................................................33 

A. Selection of Counterparties ...........................................................................33 
Table of Contents

(continued) 

 ii 

B. Relationships with Counterparties ................................................................34 

II. Cash, Margin and Collateral Management..........................................................35 

III. Selection of Key Service Providers.....................................................................35 

IV. Core Infrastructure and Operational Practices ....................................................36 

A. Operational Procedures .................................................................................36 

V. Additional Infrastructure and Operational Practices...........................................37 

A. OTC Derivative Practices..............................................................................37 

B. Practices for Other Complex Products..........................................................38 

C. Staffing and Resources..................................................................................39 

VI. Core Accounting Processes.................................................................................39 

VII. Disaster Recovery/Business Continuity..............................................................40 

Compliance, Conflicts and Business Practices ..............................................................42

I. Culture of Compliance ........................................................................................42 

II. Code of Ethics .....................................................................................................43 

III. Compliance Manual ............................................................................................44 

A. General Elements of the Compliance Manual...............................................44 

B. Recordkeeping...............................................................................................47 

C. Conflicts of Interest.......................................................................................47 

D. Training and Educating Manager’s Personnel ..............................................49 

IV. Compliance Function ..........................................................................................50 

A. Chief Compliance Officer .............................................................................50 

B. Discipline and Sanctions ...............................................................................51 

C. Annual Compliance Review..........................................................................51 
 i 

EXECUTIVE SUMMARY 

The Asset Managers’ Committee (“AMC”) issues this comprehensive Report that 

sets a new standard of best practices to answer the call of the President’s Working Group 

on Financial Markets (“PWG”) to reduce systemic risk and foster investor protection. 

The AMC, which comprises institutional alternative asset managers representing diverse 

strategies and perspectives, was formed as a private sector committee by the PWG in 

September 2007.1 Its first task was to develop guidelines that define best practices for the 

hedge fund industry.2

This call to develop best practices comes at an important time in the hedge fund 

industry.3 Over the past three decades, the hedge fund industry has evolved from a niche 

business consisting primarily of single-strategy, single-geography firms serving high net 

worth individuals into an important participant in global markets, consisting primarily of 

global multi-strategy firms serving a wide variety of institutional investors. 

With this growth comes increased responsibility. This Report represents our 

acceptance of this responsibility by promoting strong practices that are commensurate 

with the increasingly important role of hedge funds in the financial markets. The AMC 

Report: 

o Calls on hedge funds to adopt comprehensive best practices in all aspects of their 

business including the critical areas of disclosure, valuation of assets, risk 

management, business operations, and compliance and conflicts of interest; 

 

1

 PWG Announces Private Sector Groups to Address Market Issues for Private Pools of 

Capital, September 25, 2007, available at http://www.ustreas.gov/press/releases/hp575.htm. 

2

 This is the final Report, which incorporates comments received after the initial draft of the 

Report (published in April 2008). 

3

 By “hedge fund” we mean a pooled investment vehicle that generally meets most, if not all, 

of the following criteria: (i) it is not marketed to the general public (i.e., it is privately 

offered), (ii) its investors are limited to high net worth individuals and institutions, (iii) it is 

not registered as an investment company under relevant laws (e.g., U.S. Investment Company 

Act of 1940), (iv) its assets are managed by a professional investment management firm that 

is compensated in part based upon investment performance of the vehicle, (v) its primary 

investment objective is investing in a liquid portfolio of securities and other investment 

assets, and (vi) it has periodic but restricted or limited investor redemption rights. (This 

description is based in part on the definition in the Managed Funds Association’s 2007 Sound 

Practices for Hedge Fund Managers.) Although hedge funds may invest in private equity 

and real estate, this Report is not addressed to the specific considerations of private equity or 

real estate funds. We use the terms “alternative asset manager” and “manager” to refer to the 

entity that establishes the investment profile and strategies for the hedge fund and makes the 

investment decisions on its behalf. 
 ii 

o Recommends innovative and far-reaching practices that exceed existing industrywide standards; and 

o Increases accountability for hedge fund Managers. This is the first time a best 

practices Report is being released together with a separate Investors’ Report. This 

will promote accountability, and together these Reports will result in better 

managed hedge funds and better educated investors. 

Over the last several months, global markets have been experiencing a period of 

tremendous stress. While we do not yet know the full impact of this stress on the 

financial system, we recognize that it has been and will continue to be significant in many 

ways for all market participants, including hedge funds. It is clear that substantial 

discussion and debate by policymakers on how to address these challenges is underway. 

No set of best practices can resolve the complex issues facing the financial industry 

today. However, we believe that these events underscore the need for hedge funds, along 

with other market participants, to evaluate and implement strong practices to manage 

their businesses. Regardless of the results of that debate, the promotion of robust 

industry practices, such as those set forth in the Report, is an important step and will be 

critical to and consistent with the goal of reducing systemic risk and fostering investor 

protection. 

The AMC believes that even in light of all of the change and turmoil that is 

affecting all market participants, hedge funds will continue to play an important role and 

be an important source of capital and liquidity in world markets, by providing financing 

to new companies, industries and markets, as well as by committing capital in times of 

both market stress and market stability. Hedge funds’ role in helping to provide 

efficiencies in pricing of securities and other financial assets throughout the markets as a 

result of their extensive research and willingness to make investments in all market 

conditions will continue to be significant. As hedge funds have evolved and continue to 

be integral to an increasingly global and complex financial world, there is greater need 

for them to develop and maintain robust infrastructure, controls and business practices. 

Moreover, as sophisticated institutional investors have committed more of their portfolios 

to alternative investments, they have demanded that hedge funds demonstrate appropriate 

infrastructure and controls in managing their activities. We can expect this to become 

even more important to investors in light of the revelation of a massive fraud that led to 

the loss of billions of dollars. Given all of the market turmoil and other tumultuous events 

of recent months, it is more important than ever for the hedge fund industry to stand 

behind a set of far-reaching best practices that will promote the key goals of the PWG of 

reducing systemic risk and fostering investor protection. 

The AMC believes that the recommendations in this Report are responsive to 

these important concerns. We believe this Report raises the bar for the industry by 

providing strong and clear guidance to managers for strengthening their practices in ways 

that investors demand and the markets require, while also providing managers with 

appropriate flexibility to continue to innovate and grow. By adopting these practices, 
 iii 

hedge funds will strengthen infrastructure and risk management practices and controls 

that can help them more effectively manage market events or financial crises that may 

continue to arise. Indeed, we believe that these recommendations have withstood the test 

posed by the challenges of the tumultuous events that have occurred since the original 

publication and that they will be effective in accomplishing the PWG’s goals of reducing 

systemic risk and fostering investor protection. 

An Investors’ Committee (“IC”), which the PWG formed concurrently with the 

AMC, is also releasing a best practices Report for investors to help them assess hedge 

fund investments. The IC Report and the AMC Report acknowledge that both investors 

and hedge fund managers are accountable and must implement appropriate practices to 

maintain strong controls and infrastructure in support of their activities. This is the first 

time that investors and managers have come together to achieve that goal. We worked 

closely with the IC and applaud its effort to provide guidance to investors considering 

hedge fund investments. We believe that hedge fund managers should use the IC Report 

as a guideline for their interaction with investors. We believe that together these Reports 

will result in better managed hedge funds and better educated investors. 

The IC recommends in its best practices that investors use the AMC best practices 

as a guideline in conducting due diligence reviews of hedge funds. The investor 

community will be a strong partner in ensuring that hedge fund managers adopt suitably 

strong and appropriate practices to support their businesses. 

We have designed this Report to raise the standards for all managers, even the 

largest and most sophisticated. Our mandate was to develop best practices to address 

systemic risk and foster investor protection, and it is these large firms whose capital 

collectively has the largest impact on the market. We recognize that not all of the 

practices in this Report will be applicable to all managers at all times. However, our goal 

is to provide managers of all sizes with standards that they can adopt to support and 

strengthen their businesses and operations. 

We sought to identify and address the key areas where best practices would most 

effectively promote investor protection and reduce systemic risk. These areas are: 

o Disclosure: Strong disclosure practices that provide investors with the 

information they need to determine whether to invest in a fund, to monitor an 

investment, and to make a decision whether to redeem their investment; 

o Valuation: Robust valuation procedures that call for a segregation of 

responsibilities, thorough written policies, oversight and other measures for the 

valuation of assets, including a specific focus on hard-to-value assets; 

o Risk management: Comprehensive risk management that emphasizes measuring, 

monitoring and managing risk, including stress testing of portfolios for market 

and liquidity risk management; 
 iv 

o Trading and business operations: Sound and controlled operations and 

infrastructure, supported by adequate resources and checks and balances in 

operations, to enable a manager to achieve best industry practice in all of the other 

areas; and 

o Compliance, conflicts and business practices: Specific practices to address 

conflicts of interest and promote the highest standards of professionalism and a 

culture of compliance. 

Our intention is for managers to carefully assess their specific practices against 

the practices in this Report and adopt the best practices applicable to their business. What 

is critical is that managers are able to explain to investors how they have implemented 

and adopted the practices in this Report. 

Summary of AMC Report 

Frameworks: A Comprehensive Approach to Best Practices 

This Report establishes a framework for each of the five key areas mentioned 

above – disclosure, valuation, risk management, trading and business operations, and 

compliance, conflicts and business practices – to help hedge fund managers take a 

comprehensive approach to adopting best practices and serve as the foundation upon 

which those best practices are established. To implement the frameworks, hedge funds 

need to assess their business as a whole. The frameworks, while tailored to each area, 

establish a consistent and strong approach that: 1) states the goal and essential elements 

of the framework; 2) outlines clear and consistently applied policies and procedures that 

provide a structure to help ensure better educated investors and better managed hedge 

funds implement the framework; 3) incorporates a regular process for reviewing and 

updating the framework; and 4) requires adequate resources and knowledgeable 

personnel to support the framework. 

Within each framework, we set forth best practices for its implementation. We 

intend for managers to carefully assess their specific practices against the practices set 

forth in this Report. We have provided specific examples of types of best practices to 

guide managers as they conduct this assessment. For example, a long-short manager 

investing in exchange-traded securities over long time horizons likely requires a simpler 

valuation policy, that does not necessarily contain all of the practices set forth in this 

Report, than the policy of a manager trading complex OTC derivatives. Similarly, a 

manager trading equity securities globally in extremely high volumes needs more robust 

operating systems and a higher degree of automation than a manager that invests in a 

concentrated portfolio of U.S. equities. 

The manner in which each manager implements the best practices will by 

necessity differ in light of each manager’s size, strategies, products and other salient 

characteristics of its business. While we fully expect that smaller managers will be 

unable to adopt all of the practices in this Report, especially at inception, we believe this 
 v 

Report will provide helpful guidance and direction as they build and develop their 

businesses. 

A summary of our approach to the five key areas follows. 

(i) Disclosure 

This Report sets forth the basic elements of disclosure that managers should make 

available to all investors. Investors need material information to assess whether to invest 

in a fund or redeem an investment, as well as to monitor their exposure to their ongoing 

investment. The kinds of information managers disclose will vary depending on the 

strategies and structure of the fund. Looking beyond our own industry, we took note of 

the various ways in which public companies disclose information. Public companies in 

the United States are required to provide regular and ongoing information. Each year, 

they provide a comprehensive summary of their performance, including audited financial 

statements and extensive qualitative information. They also must publish quarterly 

reports, as well as updates upon the occurrence of significant events. In addition, 

investor relations departments respond to questions and provide a constant flow of 

information to investors. 

In developing best practices that will provide hedge fund investors with 

information that they need to make and monitor their investments, we drew from key 

elements of the public company disclosure regime, which provides investors with 

material information at the time of making their investment and updates throughout the 

life of the investment. We sought to take the core principles of this regime and adapt 

them to the hedge fund industry. 

The disclosure framework addresses the information that managers will disclose 

to investors to provide them with information to allow them to make an investment 

decision and to monitor it over time. This includes the provision of a private placement 

memorandum, annual audited financial statements, periodic performance information and 

other investor communications, as well as timely disclosure of significant events in light 

of the circumstances. Managers should determine (based on the specific characteristics 

of their business) the manner and frequency with which these disclosures will be made 

and clearly communicate this to investors. Public companies produce independently 

audited, GAAP-compliant financial statements. Because hedge fund investors share the 

need for accurate, independently verified financial information, we recommend that all 

hedge funds do (or continue to do) the same. 

Managers should provide periodic performance information to investors and 

provide an investor letter or similar communication and risk report on at least a quarterly 

basis. We also recommend that managers provide qualitative discussion of performance 

information (in addition to quantitative data) to provide investors with a better 

understanding of the performance of the fund. This discussion is intended to provide 

context to the manager’s performance and can be in any form or style the manager feels 

is most useful (e.g., as part of its investor letter or other disclosure). The nature of this 
 vi 

discussion will vary depending on the nature of the strategies and business of the 

manager. It should also take into account the need to protect the confidentiality of the 

fund’s positions and strategies. 

In addition to disclosure to investors, we recommend that a manager’s disclosure 

framework address its disclosure to counterparties, such as banks and broker-dealers. 

The relationships between hedge funds and counterparties are mutual and it is important 

for both sides to understand their respective credit exposures. Both parties should agree, 

at the time they initiate their relationship, on the types of information that will be made 

available. Information provided should be appropriate to the type of relationship between 

the fund and the counterparty, and be subject to appropriate protection of confidentiality. 

We believe this will help promote stable relationships with counterparties that will serve 

to mitigate systemic risk. 

(ii) Valuation 

This Report recommends that managers adopt a valuation framework that 

provides for consistent and documented policies and appropriate controls for segregation 

of responsibilities between portfolio managers and those responsible for valuations. 

Valuation of investments is of critical importance to investors in any investment vehicle, 

and in hedge fund context there are additional considerations. First, many funds invest in 

a wide range of types of assets, some of which do not have readily available market 

prices. Secondly, the funds are structured so that valuation has a direct impact on the 

compensation received by the manager. 

An essential characteristic of hedge funds is the incentive fee (or allocation) 

arrangements pursuant to which the manager participates with investors in the fund’s 

performance. This arrangement aligns the interests of managers and their investors and 

facilitates the ability of the industry to attract and retain top investing talent. However, it 

also creates the potential for conflicts of interest between a manager and the fund that 

need to be addressed and mitigated. 

Not all fund investments raise the same degree of valuation issues. For exchangetraded securities, market price information is generally widely available and valuations 

are readily and independently verifiable. However, as a fund makes investments that are 

less liquid – where the market for the investment is limited or non-existent – fund 

valuations become more complex. For example, for certain over-the-counter (“OTC”) 

derivatives, the only pricing information will be from brokers dealing in those derivatives 

and, in some cases, only from the counterparty trading with the fund. For other 

investments, such as a private investment, there may be no readily ascertainable market 

value after the initial investment is made until the investment is realized. As such, 

potential conflicts in valuing these investments may be more pronounced. 

Many financial institutions invest in illiquid or hard-to-value instruments and face 

the same challenges as hedge funds. Established mechanisms for minimizing conflicts 

include implementing a system of segregation of functions and controls with appropriate 
 vii 

oversight. This Report adopts this approach by establishing clear practices for effective 

control and segregation systems. 

The framework in this Report also establishes a governance mechanism, such as a 

valuation committee, which will have ultimate responsibility for establishing and 

monitoring compliance with the manager’s valuation policies. 

Some have suggested that the use of third-party service providers can effectively 

eliminate valuation conflicts. We believe administrators can be helpful in taking on some 

of the responsibilities related to pricing the portfolio and providing checks and balances 

in support of the manager’s policies. However, we do not believe that investors or 

managers should take undue comfort from the independence a third-party administrator 

brings to the valuation process, especially where a manager invests in hard-to-value 

assets. In such cases, it is appropriate, and indeed may be necessary, for the manager to 

be involved in the valuation process given that the manager may have the most 

knowledge about the assets in question. In addition, firms must still have appropriate 

infrastructure and resources to understand the valuation of their funds’ portfolios and not 

place undue reliance on outsourcing. What is critical is that, whether or not the fund has 

a third-party administrator, the manager needs to have in place a valuation framework 

that provides for consistent application of a valuation policy and appropriate segregation 

of functions between portfolio managers and non-trading personnel who are responsible 

for implementing the valuation process. 

We also believe that it is useful for investors to understand what portion of the 

fund is comprised of hard-to-value assets. Financial Accounting Standard 157 (“FAS 

157”) establishes a useful hierarchy of assets based on the reliability of available pricing 

information: Level 1 assets have observable market prices (such as New York Stock 

Exchange-listed stock prices); Level 2 assets have some observable market price 

information other than quoted market prices (such as broker quotes for certain OTC 

derivatives); and Level 3 assets have no observable market price information (such as 

private equity investments). 

GAAP will soon require the percentage of assets at each level to be reported on an 

annual basis, as well as the percentage of realized and unrealized profit and loss (“P&L”) 

that is derived from Level 3 (the most illiquid and difficult-to-value) assets. This 

information will help investors understand what types of assets are contributing to the 

fund’s performance and, in particular, how much of the fund’s performance is coming 

from more difficult-to-value assets. 

Recognizing the value of this kind of information, this Report also recommends 

that managers go beyond the requirements of GAAP and report the percentage of their 

assets that are in each FAS 157 level to investors more frequently (at least quarterly), and 

provide the realized and unrealized P&L information for Level 2 assets in addition to 

Level 3 assets (also at least quarterly). We recognize that the implementation of FAS 157 
 viii 

and related practices will take time and require consultation with the fund’s independent 

auditors. 

We have also provided specific guidance on side pockets. A “side pocket” is an 

increasingly common mechanism used to account for certain investments in a fund that 

are illiquid and have no readily ascertainable market value. Side pockets are generally 

limited to investors who are invested at the time the investment is made and redemptions 

from side pockets are generally not permitted until the investment is removed from the 

side pocket account upon realization of a gain or loss. 

By limiting participation in side pockets in this way, funds can protect investor 

interests by avoiding having them enter or exit such investments in the absence of reliable 

valuations. Most funds do not earn any incentive fee on the side-pocketed investment 

until the investment is deemed realized (i.e., when some kind of market-based pricing 

information is available). Thus, an added advantage of side pockets is that they mitigate 

the valuation conflict for such investments. This Report provides guidance on the 

appropriate use of side pockets. In particular, it suggests considerations managers should 

use in deciding whether to move an investment into or out of a side pocket, in valuing the 

assets in the side pocket, and in determining both fees and the associated 

investment/redemption restrictions. 

(iii) Risk Management 

Risk is inherent in investing and cannot be eliminated. Simply put, taking risk is 

essential for returns. The first and most important aspect of risk management is that a 

manager determines the overall risk profile for the fund. The risk profile will depend 

upon the fund’s size and strategy and the manager’s portfolio management process. 

We recommend that managers adopt a comprehensive framework to measure, 

monitor, and manage risk consistently with the intended risk profile. The common 

elements of the framework should be that managers identify risks to the portfolio, 

measure the principal categories of risk (such as liquidity risk, leverage, market risk, 

counterparty credit risk and operational risk), adopt policies and procedures that establish 

monitoring and measurement criteria, maintain a regular and rigorous process of risk 

monitoring, and retain knowledgeable personnel to measure and monitor risk. 

Once a risk profile is determined, managers can develop a risk management 

process to measure, monitor and manage risk in order to achieve that intended risk 

profile. Disclosure to investors will then enable them to assess whether the risk profile is 

appropriate for them and their portfolios and how the investment is performing in light of 

that profile. This Report recommends that managers regularly disclose risk information, 

including an appropriate qualitative discussion that will help investors understand how 

the manager views the fund’s risk profile. We recognize, however, that confidentiality 

remains important to the manager’s business, so it is not expected that investors will be 

provided with all information used to monitor risk. 
 ix 

Because risk management is embedded in investment philosophy, the risk 

management process will necessarily vary by fund. Specifically, it will vary based upon 

the investment strategy, the instruments traded, leverage, and the overall risk profile. 

Therefore, this Report provides illustrative examples of how firms can approach different 

aspects of their risk measurement, monitoring, and management process, including 

desirable management tools for liquidity, leverage, market, counterparty, and operational 

risk. Managers should evaluate these practices in light of their fund’s size, nature of 

business, portfolio management processes, and chosen investment strategies. 

Finally, hedge funds deal with many counterparties, including prime brokers, 

derivatives dealers and lending, trading, cash management and depositor counterparties. 

Many of these are sources of liquidity. Depending on the extent of the fund’s exposure, 

counterparty failure could have serious consequences for a fund’s access to liquidity and 

overall success. We therefore recommend that managers assess the creditworthiness of 

counterparties and understand the complex legal relationships they may have with prime 

brokers or lending or derivative counterparties and their affiliates. 

(iv) Trading and Business Operations 

As hedge funds have become increasingly complex organizations trading in 

markets all over the world, operational requirements have increased. As a result, strong 

trading and business operations are more critical than ever to the sound and effective 

operation of hedge funds. These include appropriately segregated functions, processes 

for documenting relationships with counterparties, establishing appropriate infrastructure 

to accommodate the types of investments traded by the fund and adequately managing 

and accounting for the fund’s internal operations. Managers must continuously assess the 

effectiveness of their operational and internal controls. 

This Report recommends a comprehensive framework for a manager’s trading 

and business operations. Here, too, the diversity among managers’ operations and fund 

strategies means that considerable flexibility is required. Nevertheless, we believe there 

are elements that should be common to all managers: a member of senior management 

with responsibility for operations, supported by adequate resources; policies and 

procedures that address segregation of duties and reconciliation; checks and balances in 

operations and systems; and infrastructure and automation commensurate with a 

manager’s business. 

We believe that the Report’s framework for business practices and controls, 

which includes checks and balances and appropriate use of third-party service providers, 

provides strong protection for investors. In particular, this Report also recommends that 

all hedge funds employ qualified, independent auditors, and should thoroughly 

investigate the qualifications of all service providers to the fund, including custodians, 

prime brokers (which will often provide custodial services) and, where applicable, thirdparty administrators. We believe that, when taken together with the recommendations in 

the Investors’ Report, which stresses that investors review critical third-party service 
 x 

providers as part of the diligence process, the goal of protection of investors and their 

assets will be well-served. 

The sound and effective management of trading and business operations supports 

a manager’s ability to achieve best industry practice in all of the other areas identified in 

this Report. For example, a manager’s trade documentation and settlement procedures 

are critical to accurate valuation and disclosure to investors. In addition, having adequate 

procedures to control the creation of counterparty relationships is a critical part of 

counterparty credit risk management. 

(v) Compliance, Conflicts and Business Practices 

It is critical that there be a continued commitment to the highest standards of 

integrity and professionalism within the industry. We recommend that managers have a 

comprehensive framework that includes a written code of ethics; a written compliance 

manual, including a process for handling conflicts of interest and a robust training 

program to educate personnel regarding the manager’s policies; and a compliance 

function that includes a Chief Compliance Officer, appropriate discipline and sanctions 

and an annual review of the compliance framework. Managers must implement the 

elements of the framework in light of their business and the size, strategy and profiles of 

their funds. 

Regardless of size or structure, this framework must be supported by a culture of 

compliance that begins, first and foremost, at the very top of the organization. The role 

of the Chief Compliance Officer is undoubtedly of critical importance, but a Chief 

Compliance Officer alone cannot establish this culture. A successful compliance culture 

means a commitment from the most senior levels of management and an environment in 

which each person within the firm regards compliance as his or her own responsibility 

and feels empowered to raise concerns. This level of commitment is essential to achieve 

the results that investors and market participants are entitled to expect. 

One issue of particular focus is conflicts of interest. As previously discussed, the 

potential for conflicts exists across the financial services industry and must be addressed 

for investors to continue to have confidence in the manager and in the financial markets 

as a whole. We looked to the experience of the financial services industry. The major 

investment banks were asked by the SEC to identify and analyze potential conflicts in 

their business. In this Report, we have taken it upon ourselves to identify potential 

conflicts relevant to the hedge fund industry, to help managers evaluate where conflicts 

might arise based on their own structure and operations. Many can be addressed with 

specific policies. However, it is impossible to anticipate every potential conflict. 

Accordingly, we recommend that managers establish a Conflicts Committee as the focal 

point for reviewing potential conflicts and addressing them as they arise. 
 xi 

Context for the Report 

President’s Working Group on Financial Markets 

The PWG was established by Executive Order in 1988. The PWG was given the 

mandate to enhance the integrity, efficiency, orderliness, and competitiveness of U.S. 

financial markets and to maintain investor confidence. The PWG includes the Secretary 

of the Treasury, the Chairman of the Board of Governors of the Federal Reserve System, 

the Chairman of the Securities and Exchange Commission, and the Chairman of the 

Commodity Futures Trading Commission, or their designees. 

In February 2007, the PWG released a set of principles to guide financial 

regulators as they addressed the rapid growth of private pools of capital.4 The principles 

provided a foundation to address issues of investor protection and systemic risk. This 

Report is intended to take these principles and establish best practices to enable managers 

to operate their firms in a way consistent with the PWG’s principles and guidelines. 

Industry Practices 

Many managers throughout the industry have developed strong and effective 

practices addressing many of the areas upon which we focus in this Report. Those 

managers have found that implementing strong internal controls and business practices 

has provided a platform for stability and growth, enhanced client relationships, and 

enabled them to carry out investment activities more effectively and efficiently. We have 

drawn upon many of these practices in drafting this Report. 

We also reviewed the existing recommendations for sound industry practices 

developed by a variety of other groups, such as the Managed Funds Association, the UK 

Hedge Fund Working Group, the International Organization of Securities Commissions 

and the Alternative Investment Management Association. Their work had a significant 

impact on our thinking about this Report. 

This Report does not explicitly address fund governance. Fund governance is, in 

part, dependent upon the particular organizational structure of the fund (e.g., a fund that 

is structured as a corporation will have a board of directors). We believe that investors 

should be provided with information regarding the governance structure of a fund, but the 

nature of the governance structure does not eliminate the need for, or diminish the 

importance of, senior management’s responsibility for all fund activities and operations. 

We believe that it is the responsibility of managers, and not of fund governing boards, to 

adopt and implement the best practices set forth in this Report. 

 

4

 We refer to “private pools of capital” in this Report as hedge funds. 
 xii 

Acknowledgements 

The AMC wishes to acknowledge and encourage the excellent work done by 

these and other groups in developing recommendations for sound practices in the hedge 

fund industry: 

• The Managed Funds Association (MFA) 

• The UK Hedge Fund Working Group (HFWG) 

• The Alternative Investment Management Association (AIMA) 

• CFA Institute 

• Counterparty Risk Management Policy Group 

• Dubai Financial Services Authority (DFSA) 

• Financial Services Authority (FSA) 

• International Organization of Securities Commissions (IOSCO) 

• The Greenwich Roundtable 

The AMC also wishes to thank the various members of the financial services 

industry that contributed time, expertise and perspective throughout the preparation of 

this Report. We heard from many interested parties and were very pleased with their 

interest in, and consideration of, the issues in the Report. In particular, the AMC wishes 

to acknowledge the contributions of PricewaterhouseCoopers LLP and Ernst & Young, 

who provided valuable assistance by helping the members of the AMC to develop the 

Recommendations on Valuation, and also Morgan Stanley and Goldman Sachs, who 

shared their perspectives as prime brokerage and other counterparty entities. 
 1 

BEST PRACTICES 

Disclosure and Investor Protection 

Disclosure Framework 

A Manager should establish a disclosure framework designed to disclose material 

information to investors with sufficient frequency and detail, including with respect to 

financial and risk information and potential conflicts of interest, so that investors are able 

to (i) make informed decisions regarding investments in the fund and (ii) appropriately 

monitor or manage the risks associated with exposure to the fund. A robust disclosure 

framework is critical to the protection of investors’ interests. The framework should also 

include guidelines to address providing information to counterparties (commensurate 

with the relationship with the counterparties), subject to appropriate assurances of 

confidentiality. 

The framework should include: 

1. The information to be provided to investors and the manner and frequency 

with which it will be provided (recognizing that disclosure to investors 

may take a variety of forms), including: 

(a) An offering or private placement memorandum (“PPM”); 

(b) Annual audited financial statements; 

(c) Performance information; 

(d) Investor communications (such as letters) and other reporting (such as 

risk reports); and 

(e) Timely disclosure of material information in certain circumstances. 

2. Guidelines for the disclosure of potential conflicts of interest; 

3. Guidelines for the qualifications of investors in the fund; and 

4. Guidelines relating to disclosure to counterparties. 

I. Disclosure of Material Information to Investors 

1. Disclosure begins with the fund’s offering document, typically a PPM. 

The PPM outlines the scope of the fund’s operations, including broad 

descriptions of the investment philosophy, strategies and products, as well 

as the significant risks of an investment in the fund. 
 2 

(a) A Manager should provide potential investors with a PPM or other 

offering documents or supplemental materials sufficiently in advance 

of a subscription to permit investors to adequately consider that 

information in formulating their investment decisions. 

2. For funds open to new investments, PPMs should be updated or 

supplemented at least annually in light of ongoing developments or more 

frequently in the event that a material change occurs that makes the PPM 

materially inaccurate or misleading in light of other information 

previously provided by the Manager. Any updated PPMs should be 

provided to all investors in the fund. If a previously closed fund is reopened, the PPM should be assessed to determine if it should be updated 

to reflect developments since the last time the fund was open to new 

investments. 

3. The following is a (non-exhaustive) list of types of information that should 

be included in a PPM (to the extent such information is material and 

relevant to the fund): 

(a) The legal structure of the fund, including jurisdiction of organization 

and control of the Manager of the fund; 

(b) The fund’s investment objectives, strategies and permissible 

investments; 

(c) The key investment management and other senior personnel acting on 

behalf of the fund, including: 

(i) Biographical information (including relevant educational and 

employment history and other business activities engaged in by 

any such person); and 

(ii) Information regarding any material violations of securities or 

investment-related laws or regulations, or any disciplinary action 

for professional misconduct taken against any such person. 

(d) The terms of an investment in the fund, including: 

(i) A description of applicable fees and charges, including the 

fund’s compensation structure (e.g., the calculation of incentive 

fee (or allocation) arrangements and management fees); 

(ii) Allocation of expenses such as research, legal fees and travel 

(i.e., which expenses are borne by or among the fund(s) and 

which are borne by the Manager), including a Manager’s 

policies on the use of soft dollars; 
 3 

(iii) A description of withdrawal or redemption rights and restrictions 

(including withdrawal payment and notice provisions, lock-up 

periods, notice requirements, withdrawal penalties or fees, gates, 

withdrawal suspension provisions and other redemption 

limitations, including variations in the time frame for investor 

redemptions); 

(iv) Whether fees may be paid by the fund to affiliates of the 

Manager and, if so, for what services; 

(v) A description of the Manager’s trade allocation policies; 

(vi) A description of the use of side pockets (where applicable), 

including the criteria for determining when and whether to place 

investment positions in and remove them from side pockets; 

(vii) Provisions relating to liability and indemnification of the 

Manager to and by the fund; and 

(viii) A description of the Manager’s framework for providing 

information and financial statements to investors. 

(e) Discussion of the elements of the Manager’s valuation framework, 

such as: 

(i) The use of fair value accounting in accordance with generally 

accepted accounting principles (“GAAP”) in calculating 

valuations and net asset value (“NAV”). The discussion should 

also address the use of any non-GAAP measures to compute and 

report certain asset valuations, fees, subscriptions or 

redemptions;5

(ii) The role of any third parties, including (where applicable) the 

fund’s third-party administrator, with significant involvement in 

the valuation of the investment positions in the fund’s portfolio; 

and 

 

5

 Throughout this Report, reference to GAAP is to U.S. generally accepted accounting 

principles. However, the Report recognizes that there are other broadly accepted accounting 

principles, notably the International Financial Reporting Standards (“IFRS”), which a 

Manager may adopt for its funds. This Report supports the use of standards substantially 

similar to GAAP. 
 4 

(iii) A description of the Manager’s valuation policy and the manner 

in which the Manager oversees its valuation policy, such as a 

Valuation Committee. A Manager’s disclosure regarding its 

valuation policy should include (to the extent relevant): 

● A description of the methodologies used to value the fund’s 

investment positions, including the methodology used in 

valuing various types of investment positions and the use of 

internal and external pricing sources; and 

● Ways in which the Manager mitigates potential conflicts of 

interest in the valuation process (including involvement of 

portfolio management personnel in the valuation process). 

(f) The possible risks associated with an investment in the fund, such as 

risks associated with: 

(i) The fund’s incentive fee (or allocation) arrangement; 

(ii) Reliance on and potential loss of key investment personnel; 

(iii) Lack of assurance as to the success of the fund’s investment 

strategies; 

(iv) Specific strategies or particular types of investment instruments 

and markets; 

(v) Valuation of investment positions, including valuation of 

investments with no readily ascertainable market value (see also 

the section on Valuation); 

(vi) Limited liquidity and potential restrictions on redemptions 

(including restrictions relating to redemption gates, side pocket 

investments and withdrawal suspensions); 

(vii) Use of leverage and margin (including leverage embedded in 

derivative instruments) and the possible loss of funding; 

(viii) Broker and other counterparty credit risk exposure and impact of 

potential failure; 

(ix) Investors’ reliance on a Manager’s discretion in making 

investment decisions; 
 5 

(x) A Manager’s flexibility, to the extent disclosed in the PPM, to 

allocate investments by the fund among different strategies and 

instruments; 

(xi) Investments in foreign jurisdictions; 

(xii) Presence or absence of regulatory oversight; and 

(xiii) Other factors related to investment strategy or products that 

make an investment speculative or risky. 

(g) Potential conflicts of interest in the fund’s operations (see also the 

section on Compliance, Conflicts and Business Practices);

(h) Tax, regulatory and other legal matters relevant to the fund, including 

timing on the provision of Schedule K-1s (where applicable); 

(i) Identity of any third-party administrator(s) used by the fund; and 

(j) Use of prime brokers or other lending sources. 

II. Ongoing Information Provided to Investors 

1. The Manager should provide investors with updated, material information 

on a regular and ongoing basis and communicate that information to 

investors as set forth in the Manager’s disclosure framework. 

(a) The nature of the communications and the information included in the 

communications described below should be tailored as appropriate to 

the structure of the Manager and the fund, consistent with the 

principles outlined in this section and recognizing, in certain 

circumstances, the importance of protecting confidential information 

that, if disclosed, could adversely impact the interests of the fund’s 

investors. 

(b) Updated information may be communicated to investors in a variety of 

forms, depending on the nature of the information being 

communicated (i.e., whether the information is a material development 

or part of the regular or ongoing provision of information about the 

fund). 

2. The following are types of information that Managers should consider 

providing to investors: 

(a) Investor Letters or Other Similar Communications – For many 

Managers, investor letters (or other similar communications) provide 
 6 

the opportunity to communicate in their own voice. Accordingly, it 

may be written in any form or style that the Manager desires 

(preferably at least on a quarterly basis) and would generally be 

expected to include updated information on developments relating to 

the fund, such as: 

(i) Significant shifts in investment strategy or key risk exposures 

(such as market, credit, leverage, liquidity, and operational risk); 

(ii) Changes in key personnel; 

(iii) Performance information together with examples or narrative as 

the Manager considers appropriate or useful (discussed further 

below); and 

(iv) Business, market or other significant developments, as 

appropriate. 

(b) Risk Reports – Given the dynamic nature of the risks in the portfolio, 

many Managers send risk reports to investors to provide information 

regarding the fund’s risk profile. Because the extent of risk taken and 

the approach to risk management are integral to the investment 

approach of a Manager, a Manager should disclose its approach to 

investors and provide information it believes will be informative to 

investors in light of that approach. Accordingly, a Manager should 

communicate regular risk information (preferably on a monthly basis) 

that is appropriate to the fund and its investment strategies, such as 

information regarding:

(i) Assets under management; 

(ii) Risk management (including qualitative discussions, as 

appropriate), including: 

● Asset types; 

● Geography; 

● Leverage employed in the fund (including the basis on which 

it is calculated); 

● Concentration of positions; and 

● Material changes in asset allocation. 
 7 

(c) Performance-Related Financial Information – Regular reporting of 

performance may take a variety of forms and should be provided with 

a frequency established by the Manager that is appropriate to the 

nature of the fund and the information being provided. The timing and 

content may include: 

(i) Quantitative information: 

● Annual audited financial statements prepared in accordance 

with GAAP; 

● Estimated fund performance (at least on a monthly basis) 

that clearly indicates it provides only an estimate of the 

fund’s performance and may not include other material 

expenses and items that go into calculating NAV (e.g., it 

may not include fee and expense accruals); and 

● NAV to each investor (preferably on a monthly basis) which 

should reflect each investor’s specific capital account 

balance or share value, taking account of fee and expense 

accruals in addition to trading profit and loss attributable to 

each investor’s capital account. 

(ii) Qualitative information about fund performance: 

● The goal of this information is to provide a narrative 

description, from the Manager’s perspective, that will help 

investors better understand the fund’s financial performance 

during the relevant period of time, recognizing that financial 

statements provide limited opportunities for qualitative 

discussion. This discussion may be in any form (e.g., 

investor letters, annual summaries or other disclosure) that 

the Manager desires and should include factors underlying 

the fund’s performance. 

(d) Investment-Related Financial Information and FAS 157 – In 

addition to performance information, the Manager should provide 

financial information supplementing FAS 157 to help investors assess 

the risks in the valuation of the fund’s investment positions (i.e., the 

potential for variability in the ultimate realization of the fund’s 

investment positions). Managers will need to work closely with their 

auditors for purposes of implementing FAS 157 and the related 

practices. Depending upon the extent to which the Manager invests in 

illiquid and difficult-to-value investments, the disclosures should occur 

at least quarterly and include: 
 8 

(i) Disclosure of the percentage of the fund’s portfolio value that is 

comprised of each level of the FAS 1576 valuation hierarchy: 

Level 1 (generally assets that can be priced using exchange or 

other highly liquid market prices), Level 2 (generally assets that 

have no quoted price but for which there are similar assets with 

quoted prices or pricing models using significant observable 

inputs) and Level 3 (generally assets for which observable prices 

or inputs are not available and that are generally priced using 

models or other valuation techniques); and 

(ii) Supplementing FAS 157’s requirement that Managers disclose 

the percentage of realized and unrealized profit and loss 

(“P&L”) that is derived from Level 3 assets, by making such 

disclosure with respect to Level 2 assets. 

● If the Manager deems it advisable, the Manager should 

discuss with its auditors or counsel how the information set 

forth above should be provided (e.g., on a net or gross basis) 

and inform investors of the chosen methodology. In 

addition, the Manager should identify if the manner of 

determining the information is not consistent across positions 

or levels. 

(e) Quotes – Managers should consider disclosing the percentage of the 

value of the fund’s portfolio for which only one quote was relied upon 

and the percentage for which multiple quotes were relied upon. 

(f) Specific Event Reporting – In certain circumstances, it is appropriate 

to disclose updated information or the occurrence of specific events to 

investors on a more timely basis than that provided in the regular 

course of the Manager’s disclosure framework. 

(i) As with all its disclosure to investors, Managers should assess 

the materiality of the event in considering whether disclosure is 

appropriate. In determining the appropriate timing and form of 

any reporting of specific events to investors, Managers should 

take into account factors such as: 

 

6

 FAS 157 establishes a “fair value hierarchy” that differentiates between the types of inputs 

used to determine the fair value of an asset or liability. The level in the fair value hierarchy 

within which the fair value measurement is classified is determined based on the lowest level 

input that is significant to the fair value measurement in its entirety. The examples provided 

are for illustration only and will vary depending on the facts and circumstances surrounding 

the asset valuation. 
 9 

● The nature of the information; 

● The fund’s investment program; 

● Whether disclosure of such information may compromise the 

fund’s competitive position or ability to properly manage the 

portfolio; and 

● Whether the fund is currently accepting subscriptions or 

redemptions. 

(ii) Depending on the circumstances, the following are types of 

information that should, when material, be disclosed to investors 

promptly after occurrence: 

● Changes to the fund’s valuation policies; 

● Changes to certain key investment personnel (e.g., partners 

and executive officers) or with key third-party service 

providers (such as the fund’s administrator) other than in the 

ordinary course of business; 

● Changes in biographical or disciplinary information in 

respect of investment and other key personnel of the 

Manager; 

● Entry into side letters (or parallel managed accounts) that 

grant terms to certain investors that may, in certain 

circumstances, adversely impact other investors (discussed 

further below in sub-section III.A); 

● Occurrence of operational issues that may have an adverse 

impact on the fund; and 

● Discovery of fraud or wrongdoing by the Manager or a 

significant service provider. 

3. A Manager should endeavor to provide all investors with a consistent level 

of information. In providing diligence information, a Manager may 

consider developing its own standard presentation.7

 Managers may 

employ different forms of presentation among investors, or individually 

 

7

 Managers may wish to look to guidance provided by the Managed Funds Association’s 2007 

Sound Practices for Hedge Fund Managers and the Alternative Investment Management 

Association (“AIMA”) in developing a standard presentation. 
 10 

answer questions from investors in the course of due diligence reviews or 

ongoing investor inquiries, provided the Manager does not selectively 

disclose material information among investors. 

4. Where a Manager receives requests from an investor for additional 

disclosure or clarification of existing disclosure, the Manager should 

consider whether to make the disclosure and, if appropriate, should be 

willing to make such information available to all investors upon request. 

III. Side Letters and Parallel Managed Accounts 

A. Side Letters 

1. A “side letter” generally means an agreement whereby a Manager agrees 

to provide an investor with certain information, makes certain 

representations or provides investment terms in the fund that are not made 

available to other investors in the fund. While the use of side letters may 

frequently benefit all investors in the fund (e.g., in that it enables a 

Manager to attract early or large investors), or otherwise be immaterial to 

other investors, in certain circumstances the terms of a side letter may 

have the potential to adversely impact other investors in the fund. 

2. In circumstances where side letters provide certain investors with terms 

that may adversely impact other investors in the fund, the Manager should 

make such disclosure as may be reasonably necessary to enable other 

investors to assess the possible impact of such side letters on their 

investments. 

3. The Manager should disclose, in the manner the Manager deems 

appropriate, the existence and terms of side letters containing terms such 

as those set forth below, which are generally more likely to adversely 

impact other investors: 

(a) Enhanced control rights (e.g., over investment decisions or the hiring 

of or changes in key personnel); 

(b) Preferential liquidity/redemption rights, “key personnel” provisions 

and redemption “gate” waivers; 

(c) If preferential fees are made available, a statement to that effect; and 

(d) Terms that materially alter the investment program disclosed in the 

fund’s offering documents. 
 11 

B. Parallel Managed Accounts 

1. A “parallel managed account” is a separate account established by a 

manager for a specific investor that is not an investment in a fund, but 

through which the investor invests in substantially similar strategies and 

investments as a fund. Parallel managed accounts may be sought by 

investors for a variety of reasons, including the need to comply with 

particular regulatory requirements or to impose limits on the fund’s 

investment program beyond what has been agreed to by other investors in 

the fund. 

(a) In certain circumstances, parallel managed accounts may give rise to 

issues similar to those arising in the context of side letters or may 

provide investors with terms that may, under certain circumstances, 

adversely impact other investors in the fund. 

(b) In such circumstances, the same principles that apply to the disclosure 

of side letters should apply, as appropriate, to the disclosure of parallel 

managed accounts. 

IV. Participation of Investors 

1. Managers should evaluate whether, and document how, each investor’s 

qualifications satisfy requisite legal standards appropriate to the structure 

of the fund, typically through subscription agreements. In addition to 

addressing the specific standards necessary for exemptions from 

registration under the Securities Act of 1933, the Investment Company 

Act of 1940 and other applicable U.S. and non-U.S. registration 

requirements, Managers should obtain representations from investors that 

the investor is likely to understand the material risks of investing in the 

fund, such as: 

(a) An acknowledgement that the investor has received and understands 

the fund’s PPM and organizational documents, has had an opportunity 

to obtain additional information and ask questions of the Manager and 

is making an independent investment decision based on these 

documents and the investor’s independent investigation of the fund; 

(b) An acknowledgement that the investor has the experience and 

knowledge in financial and business matters necessary to evaluate the 

merits and risks of the investment and is able to bear such risks; and 

(c) An acknowledgement that the investor understands the terms of its 

investment and the operation of the fund, including minimum 

investment, withdrawal rights, liquidity provisions, allocation and fee 

structure and other terms that the Manager thinks appropriate. 
 12 

V. Disclosure to Counterparties8

1. A Manager should foster positive and cooperative relationships with credit 

and lending counterparties (including prime brokers, derivative 

counterparties and other creditors), so that both the Manager and 

counterparties may adequately assess the risks associated with the 

relationship. Commensurate with the scope and nature of the relationship 

between the Manager and its counterparties, the Manager and its 

counterparties should agree at the beginning of their relationship as to the 

types of information and frequency with which it will be provided. Types 

of appropriate information may include: 

(a) Quantitative and qualitative disclosures regarding the strategies 

employed by the fund and the allocations between or among such 

strategies;

(b) Disclosure of the Manager’s risk management framework (including 

its approach to market and liquidity risk); and

(c) Quantitative and qualitative disclosures of the fund’s performance and 

NAV. 

2. In making disclosures to counterparties, the Manager should be willing to 

assist counterparties in understanding and interpreting disclosures. This 

may include making investment management and other key personnel 

available upon reasonable request of the counterparty to answer questions 

as part of counterparty due diligence. 

3. As a general matter, the Manager should consider whether it is appropriate 

for the level of communication with its counterparties to increase under 

certain circumstances (e.g., during times of market stress that may affect 

the fund’s strategies and performance, including during periods of 

increased volatility or tightening credit terms). 

4. In connection with any disclosures to counterparties, the Manager should 

consider information about the counterparties’ information barriers and 

policies regarding the separation of functions generally and consider 

whether it is appropriate to seek assurance, as part of its counterparty 

contracts, that financial and other confidential information provided by the 

Manager is only used for credit evaluation purposes and will not be made 

 

8

 Additional guidance and discussion of information sharing with counterparties is provided in 

the Report of the Counterparty Risk Management Policy Group II, Toward Greater Financial 

Stability: A Private Sector Perspective (July 27, 2005). 
 13 

available to any member of the counterparties’ trading desk(s) or 

department(s). 
 14 

Valuation 

Valuation Framework 

A Manager should establish a comprehensive and integrated valuation framework to 

provide for clear, consistent valuations of all the investment positions in the fund’s 

portfolio, while minimizing potential conflicts that may arise in the valuation process. 

The framework should include: 

1. A governance mechanism, such as a Valuation Committee or other 

responsible body; this body should have ultimate responsibility for (i) 

establishing and reviewing compliance with the Manager’s valuation 

policies and (ii) providing consistent and objective oversight and 

implementation of the Manager’s valuation policies and procedures; 

2. The development by the Manager of well-documented valuation policies, 

as well as guidelines to evaluate exceptions and to test and review 

compliance with policies and procedures; and 

3. Sufficiently knowledgeable and independent personnel supported by 

adequate resources that are separate from and do not report to the trading 

or portfolio management function and that are responsible for the 

valuation of the fund’s investment positions and for implementing the 

Manager’s policies and procedures. 

I. The Valuation Committee 

1. A Manager should establish a governance mechanism, such as a valuation 

committee or other responsible body (referred to herein as the “Valuation 

Committee”) that has oversight responsibility for the Manager’s valuation 

framework. 

2. Participants in the Valuation Committee should include key members of 

the Manager’s senior management (such as its Chief Executive Officer 

and Chief Financial Officer, if applicable, it being understood that their 

responsibilities may include portfolio management). 

(a) The Valuation Committee should approve valuations. It is understood 

that the Valuation Committee will not review the valuation for every 

investment in the fund’s portfolio, but will ascertain that the 

methodology set forth in the valuation policy is being followed. In 

addition, the Valuation Committee will review material adjustments or 

exceptions to the valuation policy. 
 15 

(b) While it will often be useful and important for portfolio managers or 

trading personnel to participate in the Committee (e.g., to assist the 

Committee in understanding and evaluating the valuation of certain 

investment positions, especially those with no readily ascertainable 

market value), the Committee should be structured to provide an 

appropriate measure of independence from the portfolio management 

function. The goal is to enable the Committee to benefit from the 

expertise of such personnel while mitigating potential conflicts of 

interest created by their involvement with the Committee. 

(c) Once established, the role of the Committee should be designed based 

on the structure, investment strategies and portfolio of the fund. 

Typical functions the Committee should perform include: 

(i) Developing the methods and sources used for valuing various 

classes of investment positions and material changes in such 

methods and sources; 

(ii) Reviewing and approving the Manager’s guidelines and policies 

for classification of the fund’s assets within FAS 157’s valuation 

hierarchy; 

(iii) Where broker quotes are relied upon to value a particular type of 

asset, reviewing quantitative and qualitative information such as 

the appropriateness and consistency of the sources (e.g., 

counterparty, prime broker or other source), recent trade activity 

and outliers and, where appropriate, the process by which such 

quotes are obtained and reconciled (such process having been 

appropriately documented); 

(iv) Approving the final valuations for the fund’s portfolio (and 

reviewing reconciliations with the fund’s third-party 

administrator, where applicable); and 

(v) Designating certain individuals or groups (discussed below in 

sub-section II) to be responsible for undertaking or reviewing 

certain valuation decisions. 

3. The Committee should periodically review the Manager’s valuation 

policies and procedures, including whether any patterns emerge that 

warrant modifications. Reviews should be conducted no less frequently 

than annually, or upon the occurrence of certain material events (e.g., a 

shift in the fund’s investment strategy, geographies, assets, instruments or 

sectors, or a change in market conditions or availability of pricing 

information for certain types of investment positions). 
 16 

(a) Reviews should address issues such as: 

(i) The fairness of the valuation policies and their consistent 

application; 

(ii) The continued ability of the Manager’s personnel to consistently, 

fairly and accurately apply the valuation policies; 

(iii) The selection and oversight of third-party service providers with 

significant involvement in the valuation process (including, if 

any, the fund’s administrator) and the continued ability of those 

providers to consistently, fairly and accurately apply the 

Manager’s valuation policies; 

(iv) Valuation methodologies used by the Manager and appropriate 

changes in inputs or market conditions, including illiquid 

markets; and 

(v) Any material exceptions that were made to the fund’s valuation 

polices and procedures (e.g., material price overrides). 

(b) Part of this review should include periodically back-testing a sample of 

valuations, to the extent possible and where it is likely to provide a 

reasonable base of comparison, against the recent sale prices of 

investment positions. The goal of the analysis is to provide an input to 

the Manager to help it assess the quality of models and other 

evaluative processes being employed internally or by third-party 

service providers. As such, back-testing may be particularly 

appropriate for assets in Levels 2 and 3 of the FAS 157 valuation 

hierarchy. 

(i) The focus of any back-testing would be on identifying trends in 

valuations versus sale prices, not the accuracy of individual 

marks for individual investment positions. Differences should 

be expected and viewed in the context of the overall analysis, 

especially since back-testing has inherent limitations, 

particularly during periods of market stress. 

4. Finally, the Committee should have the authority and resources available 

to consult with the fund’s independent auditor, third-party administrator (if 

any), a third-party valuation firm or legal advisor, when appropriate, to 

understand and assess new accounting requirements impacting fair value 

and in situations where it is unclear how the valuation policy should be 

applied to certain investment positions or to unique facts and 

circumstances. 
 17 

II. Implementation of Valuation Policies 

1. A Manager should have knowledgeable and qualified internal personnel 

(who may also perform other functions for the fund) or qualified third 

parties to implement the valuation policy on a day-to-day basis. As a 

general matter, the Manager should have a sufficient complement of 

personnel (internal or external) with an appropriate level of knowledge, 

experience and training that is commensurate with the nature, size and 

complexity of the fund’s portfolio. 

2. The personnel carrying out the valuation function should be responsible 

for the appropriate pricing of the portfolio in accordance with the 

valuation policy and should handle the collection and evaluation of 

counterparty prices, broker quotes, exchange prices and third-party pricing 

feeds. 

3. The valuation function should be appropriately segregated from the 

Manager’s portfolio management function. It is recognized that portfolio 

management personnel may be involved in valuation analysis and 

methodology given their expertise in certain positions. 

(a) In the event that portfolio management personnel do not believe that 

the valuation of an investment is appropriate, a Manager should have 

in place policies that seek to mitigate any conflict between portfolio 

management personnel and valuation personnel. For example, the 

Manager may develop a process for portfolio management personnel 

to “challenge” the determinations of valuation personnel in which the 

ultimate decision as to the appropriate price for a “challenged asset” 

would be made by participants in the Valuation Committee after 

consideration of pricing support provided by valuation personnel and 

input from the applicable portfolio management personnel. 

III. Valuation Policies and Procedures 

1. The adoption and implementation of comprehensive, written valuation 

policies and procedures, consistent with best industry practice, is critical to 

the design and effectiveness of the Manager’s portfolio valuation process. 

The valuation framework should be designed to promote consistent 

application of such policies and procedures and seek to provide 

appropriate information to investors and counterparties with a clear 

understanding of the limitations of such policies and procedures. 
 18 

A. Baseline Elements of the Valuation Policy 

1. The following are elements of the valuation policy that a Manager should 

consider adopting (to the extent such policies are relevant to the fund). 

Policies that: 

(a) Identify (by title or group) the parties (inside and outside the Manager) 

engaged in the valuation process: 

(i) This would include external parties involved in the valuation 

process (e.g., fund administrators or third-party valuation firms), 

participants in the Valuation Committee and personnel 

responsible on a day-to-day basis for implementing the 

Manager’s valuation policies. 

(ii) With respect to external parties involved in the valuation 

process, the Manager should clearly delineate such parties’ roles 

and responsibilities (particularly with respect to third-party 

administrators valuing portfolios and with respect to investment 

positions where the third-party is unable to independently 

substantiate prices) and provide for appropriate oversight and 

monitoring of the third-party. 

(b) Establish the appropriate methodologies to be used in valuing various 

types of investments: 

(i) Valuation methodologies should be established 

contemporaneously with the acquisition of a particular type of 

asset (where not otherwise already established) and applied 

consistently thereafter. Where the Manager undertakes a new 

type of investment, the valuation methodology should be 

documented and become part of the valuation policy. If there is 

a change in the investment that warrants a change in the 

application of policy, this change should be approved by the 

Valuation Committee. 

(ii) Methodologies should include sources of prices for different 

types of investment positions, the priority of sources within the 

valuation process and how such sources were used, such as: 

● Automated price feeds from exchanges and liquid OTC 

markets (e.g., for valuing exchange-traded securities); 

● Common models used widely by other market participants 

and based on market observable inputs such as prices of 

similar actively traded assets and liabilities (e.g., for valuing 
 19 

a total return swap on a corporate bond or exchange-traded 

equity); 

● Broker quotes for certain OTC securities (e.g., for valuing 

convertible bonds and derivatives), including policies to 

address the existence and quality of multiple broker quotes 

for a particular investment; 

● Discounted cash flow analysis and how discount rates are 

developed (e.g., for valuing a private loan); 

● Customized or proprietary models used for investment 

positions with unique features, based in part on unobservable 

(i.e., non-market) inputs (e.g., for valuing a private equity 

investment); 

● Other valuation methodologies appropriate for the type of 

asset; and 

● The process used to effect valuation adjustments. 

(c) Establish appropriate internal documentation procedures to support the 

valuation for each type of asset: 

(i) A Manager should generally maintain robust and 

contemporaneous documentation to support the valuation of 

illiquid investment positions with no readily ascertainable 

market value, in accordance with guidelines established by the 

Valuation Committee, after considering various qualitative and 

quantitative factors. In this regard, it would be prudent for the 

Manager to engage in a dialogue with the fund’s independent 

auditor in respect of the adequacy of the Manager’s 

documentation procedures for its various types of investment 

positions. 

(d) Establish appropriate procedures for the use of pricing sources, 

including price feeds, inputs to models, broker quotes and other 

information received from third-party valuation service providers; 

(e) Establish procedures for the valuation of investments placed in side 

pockets (where applicable); 

(f) Establish appropriate procedures for recording any material exceptions 

taken to the Manager’s ordinary valuation policies and the reasons for 

such exceptions; and 
 20 

(g) Provide for procedures and controls to mitigate potential conflicts of 

interest in the valuation process (including the involvement of 

portfolio management personnel in the valuation process). 

B. Investment Positions with No Readily Ascertainable Market Value 

1. Certain investment positions in the fund’s portfolio may have no readily 

ascertainable market value. For many Managers these types of 

investments (e.g., private equity investments) are an important source of 

potential returns for the fund. Generally, as part of the disclosure in the 

PPM, investors should be informed of whether these types of investments 

may be made by the fund. 

2. While a fund should generally seek competent and independent review or 

generation of its final valuations, in the case of investment positions with 

no readily ascertainable market value it may be necessary or appropriate to 

utilize properly controlled internal valuations given the absence of 

adequate external valuations. Accordingly, the Manager must be 

particularly vigilant as the potential conflicts inherent in valuing 

investment positions can be more pronounced in this context. 

3. To mitigate these conflicts, valuation policies and procedures should 

address the circumstances in which the Manager may rely upon models, 

the required support and documentation when using a model and the 

manner and frequency of reviewing models. In particular, any material 

exceptions or unusual situations arising in the context of a pricing model 

(e.g., the creation of a unique pricing model for a particular asset) should 

be documented and reviewed by the Valuation Committee. 

C. Side Pockets and Other Similar Arrangements 

1. A “side pocket” is an increasingly common mechanism used to account 

for certain investments of a fund that are illiquid and have no readily 

ascertainable market value. Certain funds provide for side pockets to 

protect investors by avoiding the need for them to transact (redeeming or 

investing) in respect of such investments, where there is greater inherent 

subjectivity in their valuation prior to realization or other key event. 

Moreover, by not assessing an incentive fee or allocation until the 

investment in a side pocket is realized (or deemed realized) an additional 

valuation conflict is avoided. 

2. Where a fund provides for the use of side pockets, the Manager should 

include in its policies and procedures guidelines regarding their use, such 

as: 
 21 

(a) The appropriate considerations for determining if/when an asset should 

be moved into or out of a side pocket (including, where applicable, any 

related hedges and financial transactions). Relevant considerations 

include: 

(i) The availability of third-party evidence of value (i.e., whether 

any observable market inputs, broker quotes or other types of 

evidence exists that can provide an indication of value); 

(ii) The extent to which the investment is inherently difficult to 

value (e.g., equity investments in private versus public 

companies); 

(iii) The nature of the market for the investment (i.e., whether the 

market is developed or emerging, highly liquid or illiquid and 

the extent to which the market is regulated); 

(iv) The anticipated ability to exit the investment (including whether 

the investment is freely tradable or subject to contractual, legal 

or regulatory limitations on its realization, or, where applicable, 

the stage of development of a business and how soon it may be 

ready to go public); and 

(v) Any applicable contingencies or special events upon which the 

investment’s realization will depend. 

(b) The policies for valuation of investments held in side pockets (which 

should be the same as the policies applied to investments not held in 

side pockets, as required by accounting rules). The nature and 

frequency of review of particular side pockets should be appropriate to 

the type of investment and market conditions that may be expected to 

have an impact on that investment. 

(c) Regular review and approval by appropriate personnel of any transfer 

of an investment to a side pocket, other than at the time the investment 

is made. Recognizing that there are many circumstances in which a 

transfer of an investment to a side pocket may be appropriate, the 

Manager should have a process to review and approve such transfers. 

It may be prudent for the Valuation Committee to review or approve 

any such transfers. 
 22 

Risk Management 

Risk Management Framework 

Risk is inherent in the investment process and is essential for return. The goal of risk 

management is not to eliminate risk but to manage it prudently. A Manager should 

establish a comprehensive and integrated risk management framework that is suited to the 

size, portfolio management process and investment strategies of its funds. Through the 

risk management framework, the Manager should identify the risks inherent in its chosen 

investment strategies, and measure and monitor its exposure to these risks to be 

consistent with the Manager’s intended risk profile. The risk management framework 

should be communicated to investors to enable them to assess whether the fund’s risk 

profile is appropriate for them and how the investment is performing against that profile. 

The framework should address: 

1. Identification of material risks to which the portfolio may be subject; 

2. Measurement of the principal categories of risk (including liquidity risk, 

leverage, market risk, counterparty credit risk and operational risk); 

3. A regular process of risk monitoring, appropriate for the size of the fund, 

its portfolio management process and the complexity of its investment 

strategies; 

4. Policies and procedures establishing measurement and monitoring criteria; 

and 

5. Knowledgeable personnel to measure and monitor risk as established by 

the policies and procedures. 

I. The Manager’s Approach to Risk Management 

A. Identification and Design 

1. Senior management should determine the overall risk profile for the fund. 

2. The Manager should identify risks and determine how it intends to 

manage these risks to meet the fund’s risk profile. The Manager should 

develop a risk management process designed to measure and monitor the 

risks and enable investors to make informed decisions about the risk 

profile of the fund and its fit within their own risk tolerance. 

(a) The principal, widely recognized categories of risk are liquidity risk 

(including both asset and funding liquidity), leverage, market risk, 

counterparty credit risk and operational risk (each discussed further in 
 23 

sub-section II). The Manager should consider the extent to which 

these categories of risk apply to its fund, and the kinds of methods that 

will be used to measure, monitor and manage the applicable risks 

(such as stress testing and scenario analysis, VaR, volatility measures, 

concentrations metrics and other approaches). In particular, stress 

testing and scenario analysis are often desirable risk management 

practices.

(b) While objective measures of risk are critical to understanding how the 

portfolio behaves, qualitative factors are also important when 

analyzing portfolio risks. 

3. A member of senior management, such as a Chief Risk Officer (or other 

person with similar responsibilities), or a Risk Committee, should 

establish risk measurement criteria and implement a process to monitor the 

portfolio’s risk profile. 

(a) Implementation would be based on the overall structure of the 

portfolio, investment and trading strategies, the level of centralization 

of the decision-making process, the capital allocation process and 

consistency with the overall investment and risk profile of the fund. 

(b) When implementing a risk management framework, a Manager should 

consider the issues set forth above to determine: 

(i) Which risk measures (e.g., capital, concentration or liquidity) 

should be monitored within the overall framework; and 

(ii) Whether to apply constraints in risk management (such as limits) 

and how to apply them (e.g., whether to adopt hard limits, which 

can never be exceeded, or soft guidelines, which involve 

discussions of the current risk level faced by the portfolio). 

B. Measurement, Monitoring and Management 

1. Where possible, material risks taken by the fund should be quantified and 

monitored at a frequency appropriate to the characteristics of the fund’s 

portfolio. 

2. Those material risks which are not quantifiable or measurable should still 

be monitored. 

3. No risk management process is capable of providing a complete 

representation of all of the risks facing the portfolio or accurately 

measuring every one of those risks. The portfolio should be reviewed on a 

periodic basis (the frequency of this review depending on factors such as 
 24 

the nature of the portfolio and market conditions). This review should 

qualitatively assess whether the portfolio is performing consistently with 

expectations (based on the identified and measured risks) and, when it 

varies, review the factors that might be affecting the portfolio. 

4. As risk management is a subjective process, the Manager should 

understand the biases and limitations of its chosen risk measurement 

methodologies (including models) and adjust for these in measuring and 

making decisions about risk. 

5. Risk reports describing the portfolio’s exposures to the key risks identified 

by the Manager should be prepared and distributed to senior management 

responsible for the portfolio with a frequency appropriate to the nature of 

the portfolio. 

C. Personnel 

1. Senior management should appoint knowledgeable personnel to supervise 

risk analysis, measurement and monitoring and to take responsibility for 

the creation of policies and procedures covering all areas of risk 

management. 

(a) This supervisory role may be performed by a Chief Risk Officer (or 

other person with similar responsibilities) or by a formal Risk 

Committee comprised of members of senior management with 

sufficient experience and the relevant background to understand the 

complexities of the risk framework. In that role, these persons may 

also be involved in the portfolio management process. 

(b) The Chief Risk Officer (or other person with similar responsibilities) 

should have open access to and engage in regular dialogue with the 

portfolio managers as well as the fund’s senior management, so that 

he/she can acquire a clear understanding of the fund’s positions and 

strategies. 

2. Senior management should not outsource risk monitoring or management, 

and must maintain responsibility for the overall risk framework. If a 

determination is made to use the services of an external provider only for 

risk measurement, outsourcing should not be a substitute for an adequate 

understanding of risk by senior management personnel. 

(a) Responsibility for any outsourced parts of the process should continue 

to lie with the senior management or its designees, such as the Chief 

Risk Officer or designated Risk Committee. 
 25 

II. Categories of Risk 

The emphasis on the categories of risk that will need to be measured, monitored and 

managed will vary depending on the products the Manager trades, investment strategies, 

and frequency of trading it chooses for its funds. Accordingly, within the Manager’s risk 

management framework, the Manager should consider what categories of risk are 

material to the fund and adopt risk management measures most appropriate to its 

investment approach. 

To assist Managers in this regard, the balance of this section describes the principal 

categories of risk that a Manager may need to measure, monitor and manage in the 

operation of its business. The discussion also provides examples of measuring 

techniques and risk management tools that may be applicable to each category of risk. 

While Managers should reflect on the broad categories of risk (discussed immediately 

below), the particular risk management methods undertaken by a Manager should be 

appropriately tailored to the specific risks faced by the fund and the fund’s risk profile. 

Accordingly, in many cases certain of the risk management tools described below may be 

less relevant to a particular Manager, while in other cases a Manager may determine that 

it should use risk management tools not described here. 

A. Liquidity Risk 

1. Liquidity is the Manager’s ability to meet its need for cash. Sufficient 

levels of liquidity enable the Manager to meet its obligations. The 

following are types of factors that a Manager should take into account in 

managing liquidity: 

(a) The risk of a reduction in the funding provided by lending 

counterparties, including changes to initial margins/credit support and 

timing or size of variation margin calls, as per various agreements with 

counterparties; 

(b) The terms of redemption rights by investors and the amount of 

investor capital that is subject to those redemption rights; and 

(c) Changes in market liquidity conditions (including trading volume, bidask size and spread and the possible effect of 

crowdedness/concentration of trading strategies) that may alter the 

ability of the Manager to sell securities with minimum adverse price 

impact or otherwise manage the liquidity of the portfolio. 

2. The Manager should seek to increase the stability of external factors 

affecting the portfolio through prudent agreements with lenders and 

investors. 
 26 

3. The Manager should thoroughly understand and regularly review the 

material terms in its credit and lending agreements, including the 

interaction of those terms, cross-default and cross-collateralization 

provisions, and their impact on collateral management and requirements. 

These terms may affect the availability of funding in the event of certain 

extreme market conditions or triggering events (e.g., limitations on prime 

brokers’ obligations to provide financing under certain circumstances or 

NAV triggers) and the overall risk faced by the fund. In addition, the 

Manager should review these agreements from the perspective of how 

they protect the fund from the risks arising in the event of adverse 

developments with respect to the counterparty. 

4. The Manager should consider regularly conducting liquidity stress 

scenario analyses on the portfolio(s) in order to understand and better 

manage its ability to meet obligations in light of the fund’s portfolio. 

5. The Manager should be aware of the risks of holding certain short-term 

cash-like instruments (such as money market investments and short term 

securities that depend on a liquidity put) as a substitute for cash in light of 

the potential for illiquidity, unexpected delays in satisfying redemptions 

and the resulting mis-matches in funding requirements. 

B. Leverage Risk 

1. Leverage is the practice of using borrowed money to make investments. 

For portfolios without derivative contracts, leverage may be defined as the 

market value of assets relative to the fund’s capital. For more complex 

portfolios or portfolios containing derivatives, it may be more appropriate 

to estimate leverage by analyzing the risk of different strategies and 

understanding the potential for extreme losses arising from those 

strategies. The Manager should manage its use of leverage to match the 

risk profile established for the fund based on its size, portfolio structure 

and specific investment strategies. The Manager should monitor changes 

in this measure over time as part of its risk management framework, and 

should take account of on- and off-balance sheet assets (e.g., derivative 

instruments, including OTC derivatives) in measuring leverage. 

(a) The Manager should monitor leverage with a frequency appropriate to 

the characteristics of the underlying portfolio taking into account the 

potential impact of various inter-related factors such as:

(i) Asset types, sectors and positions;

(ii) Overall liquidity profile of the portfolio;

(iii) Trading strategies employed by the Manager;
 27 

(iv) Volatility of assets and trading strategies; and 

(v) The crowdedness/concentration of trading strategies. 

(b) The Manager should thoroughly understand the terms on which prime 

brokers, lenders and other trading counterparties provide leverage to 

the fund and seek sustainable credit, margin and funding terms in order 

to manage its leverage prudently and minimize additional stress when 

market conditions become volatile. Important terms may include 

constraints on the portfolios (e.g., concentration, diversification and 

liquidity limits) and prime brokers’ and counterparties’ rights to alter 

these terms. 

(c) The Manager should take into account the impact of employing 

leverage on any positions with embedded leverage, such as certain 

types of derivatives and other structured products. 

C. Market Risk

1. Market risk is the financial risk brought about from changes in the market 

price of investments in the portfolio. The Manager should regularly 

evaluate market risk, incorporating some or all of the following risk 

measures, as applicable to the fund’s size and portfolio management 

processes and the complexity of its investment strategies. The list below 

comprises the primary market risk processes used in the industry. A 

Manager should model its risk management framework through the 

inclusion of some or all of these in such framework:

(a) Risk exposures for different market variables and asset classes:

(i) The Manager should seek to identify the size and direction of its 

exposures to major market risk factors (e.g., equity indices, 

interest rates, credit spreads, foreign exchange rates and 

commodities prices). 

(ii) These exposures should be considered both on a gross (longs 

plus shorts) and net (longs less shorts) basis and examined both 

within individual strategies and portfolios and across the entire 

fund. Risk systems should also distinguish between linear 

exposures (i.e., prices that change proportionately with changes 

in the overall market) and non-linear exposures (i.e., those that 

arise from instruments such as options, convertibles and callable 

bonds). 

(b) Conducting stress tests and scenario analyses:
 28 

(i) The Manager should conduct stress tests and scenario analyses 

of its portfolio. Stress testing and scenario analyses can be 

useful in assessing the vulnerability of a portfolio to various 

events. They should be designed to capture both market events 

(directional movements) and situations of market illiquidity. 

The frequency of such testing should depend on the nature of the 

portfolio, the risks to which it is exposed, the frequency of 

turnover and changes in market conditions, among other factors. 

The Manager should identify which market variables to stress, 

how much to stress them by and over what time frame. 

(ii) Stress tests/scenario analyses can be based on standardized 

measures, historical events or unique scenario analyses. 

● Standardized stress tests involve shocking major market 

factors by a constant amount or percentage moves (e.g., “All 

interest rates rise by 100 basis points”, or, “Equity prices 

drop by 10%”). Using both approaches enhances stress 

testing with regard to factors that may undergo regime shifts 

(i.e., moving from tight to wider credit spreads, or from a 

low to higher volatility environment). These tests are useful 

tools to translate risk exposures into potential profits and 

losses given a major change in the market. 

● Historical scenario analyses aim to measure the expected 

behavior of the portfolio if a period of known market stress 

reoccurs in the future. The calculation process must adjust 

for new instruments and changes in market structure. 

● Unique scenario analyses aim to measure the expected 

behavior of the portfolio during an unexpected period of 

stress, as specified by risk management.

(c) Use of historical statistical risk measures of the portfolio: 

Historical risk measures aim to understand the historical behavior of a 

portfolio versus expectations and can be used as a predictor of future 

behavior when asset composition and market conditions are relatively 

stable. 

(i) If the Manager determines to monitor historical statistical 

portfolio risk measures, the Manager should do so by analyzing 

measures such as realized volatility, return as a function of 

volatility, worst drawdown, historical beta and correlation with 

relevant market indices. 
 29 

● It is prudent to analyze these measures at a frequency 

appropriate to the characteristics of the fund in order to 

understand how these realized risk measures may differ over 

various time horizons. 

(ii) Such measures may become less relevant if the asset or strategy 

composition of the portfolio changes frequently, the market 

structure evolves (e.g., regime shifts) or the periodicity of 

valuation is inappropriate (e.g., daily volatility may be an 

inappropriate measure for investment positions that are markedto-market monthly). 

(d) Use of forward-looking statistical risk measures: 

Forward-looking statistical risk measures aim to forecast the expected 

behavior of the portfolio through quantitative techniques using 

assumptions on the volatility and correlations of assets in the portfolio. 

(i) If the Manager determines to use prospective statistical measures 

as a risk monitoring tool, the Manager should consider which 

forecasted statistical measures are applicable to its portfolio. 

Two common, though not universally used, examples are Value 

at Risk and Expected Loss. 

(ii) When using forward-looking statistical measures, their 

shortcomings should be recognized. These measures commonly 

use a normal distribution of returns as the basis of the 

calculations. However, because financial markets frequently 

exhibit unusual, so called “fat-tailed” behavior, many forwardlooking statistics systematically underestimate portfolio risk. 

Moreover, assumptions concerning the volatility of the assets in 

the portfolio and the correlations between assets may not reflect 

actual experience. In addition, these measures may be difficult 

to calculate for multi-asset portfolios and portfolios with 

optionality. 

2. Where applicable to the fund and its investment strategies, the risk 

management process should examine whichever it uses of the measures 

outlined above at both the overall fund or portfolio level as well as by 

individual investment strategy, asset class, industry group, geographical 

region or other dimensions. 

3. In light of the use of assumptions and uncertainty with respect to events, 

risk measures may provide more insight when looked at over time. A 

particular data point may be more useful when viewed in the context of 
 30 

how that same measure has changed over previous days, weeks and 

months. 

4. It is important to periodically review the performance of models used to 

measure and monitor market risk and adjust as appropriate to maximize 

effectiveness. This may be performed by measuring risk estimates over 

time against the realized return of the portfolio. 

(a) Changes to models and assumptions should be made to factor in new 

data and to account for previously unrecognized relationships or risk 

factors; and 

(b) Managers should understand the limitations inherent in risk models, 

such as assumptions in the inputs and limitations of historical data. 

They should use results from these risk models after quantitatively 

taking into account these limitations. 

D. Counterparty Credit Risk

1. The Manager should monitor its fund’s exposure to counterparty credit 

risk (including, as applicable, prime brokers, derivatives dealers and 

lending, trading, cash management and depositor counterparties) and 

understand the impact of potential counterparty loss of liquidity or failure. 

(a) The Manager should assess creditworthiness when selecting and 

transacting with counterparties (recognizing that subsidiaries and 

affiliates of counterparties may have different creditworthiness than 

parent companies). 

(b) The Manager should understand the complexity of the legal 

relationships a fund may have with its prime brokers and any other 

significant lending or derivatives counterparties and their affiliates, 

including: 

(i) Understanding the legal entity with which the fund has 

contracted. the fund’s ability or inability to close out or net 

positions with a certain counterparty or prime broker and its 

affiliates in the event of an insolvency proceeding or other 

default and the impact of insolvency on the fund’s rights with 

respect to and its ability to access positions; 

(ii) Understanding the way in which the prime broker finances the 

fund’s positions, including whether it uses US and/or non-US 

broker-dealers or banks, whether assets are segregated and 

rehypothecated and the location in which its positions are held; 

and 
 31 

(iii) Knowing the identity of custodians and sub-custodians used by 

the prime broker in various locations and, depending on the 

availability of resources, assessing the risk associated with the 

use of such custodians and sub-custodians, particularly in 

developing markets. Factors to be taken into account include the 

risk/reward of investing and the size of the business with that 

particular sub-custodian. 

2. The Manager should measure and monitor its credit exposure to each 

counterparty (as appropriate given the level of the fund’s exposure to each 

counterparty). 

(a) As part of this process, the Manager should weigh the desirability of 

diversifying counterparty credit risk by using multiple prime brokers 

and counterparties against any increases in the complexity and 

practicality of settlement, reconciliation processes and daily collateral 

management. The Manager should dedicate appropriate resources to 

manage its collateral movements and, where possible, aim to reduce 

mismatches at a counterparty (e.g., by maintaining reasonably hedged 

portfolios at each prime broker). 

(b) To minimize risk in the event of market stress, the Manager should 

consider taking steps to increase its access to liquidity, such as opening 

cash and custody accounts at financial institutions other than its prime 

brokers. 

E. Operational Risk 

1. The Manager should have a strong operational infrastructure that is 

commensurate with the complexity of its business, to manage and mitigate 

operational risks resulting from inadequate or failed internal processes, 

people and systems, or from external events. 

(a) One or more senior operating officials, who may include a Chief 

Operating Officer, with functions separate from investment 

management, should oversee the Manager’s operational areas. 

(b) The Manager should implement and maintain strong internal controls 

to minimize the risk of loss as a result of operational risk. 

(c) Controls to reduce operational risk may include (as applicable to a 

Manager): 

(i) Use and maintenance of a centralized position data set; 

(ii) Adoption of trade capture devices; and 
 32 

(iii) Prompt reconciliation of trading information with the fund’s 

prime broker or settlement agent and administrator. 

(d) The Manager should monitor its overall level of operational risk, either 

internally or through third-party review. This review may take into 

account the following characteristics of the Manager (as applicable to 

a particular fund): 

(i) Assets and products; 

(ii) Staffing and resources; 

(iii) Infrastructure (including information technology resources, 

business continuity, and disaster recovery planning); and 

(iv) Compliance and regulation. 

(e) Additional guidance on managing operational risk is provided in the 

section on Trading and Business Operations. 
 33 

Trading and Business Operations 

Trading and Business Operations Framework 

A Manager should develop a comprehensive and integrated framework to manage trading 

and business operations, taking into account the size and complexity of its activities, the 

nature of its investment, and the requirements of its investment strategies. 

The framework should include: 

1. Policies and procedures which provide for appropriate checks and 

balances for the significant operational and accounting controls, including: 

(i) appropriate selection and management of counterparty relationships; 

(ii) effective management of cash, margin and collateral requirements; (iii) 

careful selection of key service providers; (iv-v) strong infrastructure and 

operational practices; (vi) strong operational and accounting processes, 

including appropriate segregation of business operations and portfolio 

management personnel; and (vii) a disaster recovery process; 

2. Systems, infrastructure and automation commensurate with the scale of 

the business and trading operations of the Manager, including regular 

review of such infrastructure to assess operational risks in light of both 

internal and external changes; and 

3. A member of senior management, such as a Chief Operating Officer or 

person with similar responsibilities, with responsibility for the Manager’s 

business operations, supported by internal personnel or, where applicable, 

external resources, with skills appropriate to the complexity of the 

Manager’s business operations. This role and the operational areas of the 

firm should coordinate and work in partnership with the investment 

professionals and senior management. 

I. Counterparties 

A. Selection of Counterparties 

1. Managers interact with a variety of counterparties and should exercise 

reasonable due diligence in selecting the counterparties of the funds that 

they manage. Typical counterparties that a fund will encounter include: 

(a) Brokers; 

(b) OTC derivative counterparties; 

(c) Prime brokers; 
 34 

(d) Stock loan and repo counterparties; 

(e) Banks; and 

(f) Cash management counterparties. 

2. When selecting counterparties, the key factors that a Manager should 

consider include: 

(a) Creditworthiness, reputation, experience and identity of the specific 

entity; 

(b) Ability to provide an appropriate level of service to the Manager in 

light of the Manager’s business needs (including complexity of 

products and frequency of trading), such as: 

(i) Efficient and timely transaction processing, reporting, clearing 

and settlement; 

(ii) Financing capabilities necessary to support the Manager’s 

business; 

(iii) Adequate staff to be able to service the Manager’s needs, 

including the support and reporting of information to prepare 

books and records; and 

(iv) Terms and conditions for movements of margin and cash 

required by transactions. 

(c) Regulatory environment in which the counterparty operates; and 

(d) Stability of terms on which the counterparty is willing to provide 

service to the Manager (such as term funding lock-ups for prime 

brokers). 

B. Relationships with Counterparties 

1. The Manager should negotiate and maintain with its counterparties signed 

agreements governing the terms of the relationship (e.g., account opening, 

prime brokerage, stock lending, ISDA and give-up agreements). 

2. The Manager should carefully review the details of the terms of these 

agreements to understand risks that can affect the counterparty’s 

obligation to extend credit or provide other services (such as terms that 

can increase collateral requirements). 
 35 

3. Where multiple counterparties are used, the Manager should devote 

appropriate resources to managing the operations of the fund across those 

multiple counterparties. 

II. Cash, Margin and Collateral Management 

1. The Manager should have a framework for managing its cash balances and 

processing any margin or collateral calls from its prime brokers, financing 

and OTC derivative counterparties. In developing this framework, 

Managers should carefully consider industry practices and developments 

in this area. 

2. The Manager should: 

(a) Understand and monitor its compliance with credit agreements; 

(b) Understand and monitor the amount and type of collateral required to 

support positions; 

(c) Verify marks used by the fund’s counterparties to value the fund’s 

positions for collateral purposes; and 

(d) Verify and meet margin calls in a timely manner. 

III. Selection of Key Service Providers 

1. The Manager should select reputable service providers that have expertise 

and experience suitable to appropriately support its business. These 

service providers may include, where appropriate: 

(a) Providers of accounting, consulting, and proxy services, IT product 

vendors, and legal counsel; and 

(b) The fund’s administrator (where one exists). 

2. The Manager’s selection and monitoring process for its service providers 

should take into consideration each service provider’s independence and 

controls over its activities. 

3. In engaging key service providers, the Manager should enter into 

agreements that clearly delineate the service levels to be provided to it. 

Such services should be appropriate in light of the Manager’s internal 

infrastructure and the complexity of the Manager’s operations. 

4. The Manager should monitor the quality of service provided by key 

service providers. 
 36 

5. Responsibility for any outsourced parts of the process continues to lie with 

senior management or its designees. 

IV. Core Infrastructure and Operational Practices 

1. The Manager should develop infrastructure and operational practices 

tailored to its business. Requirements for the infrastructure needed will 

vary depending on the types of investments, frequency of trading, and the 

need for manual processing, as opposed to the availability of automated 

systems. 

2. The Manager should consider whether the implementation of automated 

processing systems is appropriate to reduce settlement risk. Depending on 

the size and complexity of the organization, automation may be 

appropriate, where available. 

3. The Manager should provide for appropriate reporting-up policies for 

resolving material breaks, errors or other matters that could potentially 

cause risk of loss to the fund. The Manager should employ businessprocess monitoring, analysis and optimization techniques to identify and 

address breaks and inefficiencies. 

4. Depending on the size and complexity of the organization, the Manager 

should endeavor to cross-train personnel or otherwise have appropriate 

back-up, so that key operations functions are not dependent solely on one 

individual. 

A. Operational Procedures 

1. The Manager should adopt procedures for clearing and settling 

transactions and for wiring funds. Such procedures may address: 

(a) The reconciliation of positions and cash accounts across 

counterparties, such as prime brokers, futures clearing accounts, the 

fund’s administrator and front office, including prompt resolution of 

failed trades; 

(b) An appropriate procedure for cash movements, including authorized 

signatories and appropriate checks and balances; 

(c) The appropriate segregation of duties between investment and 

operational personnel, including confirmations that should be sent to 

non-trading personnel; 

(d) The use of industry utilities and software tools (such as DTCC 

Deriv/Serv) in an effort to automate the Manager’s OTC derivatives 
 37 

processes, where the volume and complexity of a Manager’s business 

warrants it; 

(e) A process for addressing corporate actions, such as mandatory 

elections, voluntary elections, dividends, splits and reorganizations; 

and 

(f) A process for monitoring and taking timely action on all positions that 

have expiration dates (e.g., options, warrants, rights and conversions). 

V. Additional Infrastructure and Operational Practices 

1. If a Manager undertakes material trading activities in the OTC derivatives 

market or other more complex markets (such as bank debt, mortgagebacked securities, equity derivatives, structured credit trading or private 

transactions), the Manager should devote the resources necessary to 

maintain infrastructure, personnel and processes that are sufficiently 

robust to handle the added complexities of these instruments and markets, 

including working closely with counterparties and remaining informed of, 

and responsive to, overall market trends. A Manager who trades in 

complex products should consider the need to maintain additional systems 

or to hire or engage personnel with specific skill sets necessary to 

appropriately manage such complex products. The lists below represent 

examples of derivative and complex product practices and are neither 

exclusive nor exhaustive. 

A. OTC Derivative Practices 

1. The fact that OTC derivatives are individually negotiated transactions that 

can have unique characteristics and terms makes them especially 

challenging to manage from an operational and business perspective. 

Accordingly, when trading in OTC derivatives, the Manager should 

consider the need for the following: 

(a) Negotiating appropriate ISDA master agreements with all of its OTC 

derivatives counterparties (discussed further above in sub-section 

I.B.1); 

(b) Negotiating bilateral collateral agreements with its counterparties 

whenever possible; 

(c) Appropriate systems to record all material terms of all OTC contracts 

to facilitate the appropriate pricing and risk management of these 

portfolios; 
 38 

(d) Processes to monitor and promptly report-up the resolution of any 

derivative transaction not supported by a counterparty term sheet 

detailing the economics of the trade; 

(e) Procedures for monitoring outstanding confirmations (e.g., not yet 

received, in review, disputed, or aged) and performing risk analysis, 

timely mitigation (e.g., prioritization) and expeditious resolution of 

outstanding confirmations; 

(f) Review of counterparty OTC margin calls and a process for assessing 

when the Manager should make its own OTC margin calls to brokers, 

as appropriate; 

(g) Appropriate processes and procedures to facilitate the Manager’s 

ability to adhere to the industry’s novation protocol and transaction 

processing timelines, and other industry protocols that may develop; 

and 

(h) Review of final payoffs for complex derivatives. 

B. Practices for Other Complex Products 

1. Bank Loans – The Manager should assess whether it has the appropriate 

systems and personnel to manage the extended settlement cycles and 

unique features of these products. In addition, legal advice from 

appropriately skilled internal or external counsel is often needed to 

manage the documentation around these transactions, particularly in the 

distressed arena. 

2. Mortgaged Backed Securities/CMOs – The Manager should assess 

whether it has appropriate systems and personnel to manage the unique 

features of these products, such as processing monthly paydowns and 

understanding payment waterfalls. 

3. Structured Credit Trading – The Manager should assess whether it has 

the appropriate systems and personnel necessary to manage the unique 

features of these products, such as the financing component, waterfall 

structures and correlations. 

4. Private Transactions – The Manager should assess whether it has 

appropriate resources such as internal and external legal, tax and 

structuring expertise that is adequate to support these transactions. In 

addition, custodial arrangements may be needed to provide for appropriate 

safeguarding of investment positions of this type. There should be 

periodic confirmation with counterparties of open positions. 
 39 

5. Transactions in Foreign Markets – These types of transactions require 

an understanding by personnel or service providers of local regulatory, 

market and tax infrastructure and settlement conventions. 

C. Staffing and Resources 

1. The Manager should regularly assess the appropriate level of staffing and 

resources for complex or unique trading strategies from an operational and 

business risk perspective and be willing to maintain that level. 

VI. Core Accounting Processes 

1. The Manager needs to have appropriate systems, processes, and personnel 

in place, such that the trading activity of its funds and all related 

contractual arrangements and agreements can be appropriately recorded 

from an accounting perspective to allow for the calculation of both fundlevel and investor-level net NAVs, as well as the production of other 

important financial data that is necessary to meet investor, risk, financial 

statement and tax reporting requirements. In this regard: 

(a) The Manager should have internal or external personnel with an 

appropriate level of accounting knowledge and experience; 

(b) The Manager should have access to systems appropriate to the needs 

and complexities of the firm, capable of correctly recording the trading 

and non-trading activities of the funds from an accounting perspective. 

These may include: 

(i) Systems that maintain important trading-related data, including 

quantity, cost-basis, market-value, realized and unrealized 

trading gains/losses, interest and dividends, and trading-related 

fees and expenses; 

(ii) A general ledger that includes trading data (whether in detailed 

or summarized form), as well as non-trading-related data, such 

as management fees and expenses; 

(iii) An allocation process that allocates the fund level results to 

individual investors to allow for reporting at the investor level; 

and 

(iv) Processes (in addition to the valuation processes discussed 

above in the section on Valuation) to ensure that all non-tradingrelated activities are appropriately recorded from an accounting 

perspective, including management fees, incentive fee (or 
 40 

allocation) arrangements and other fees and expenses, as 

outlined in the fund’s organizational documents. 

(c) The Manager should implement a month-end close process (or if not 

monthly, then at least as often as required by the fund’s organizational 

documents). Some processes that may be appropriate in light of the 

characteristics of the fund include: 

(i) Verification that any material valuation adjustment is 

appropriately recorded; 

(ii) Verification that all non-trading-related activity is appropriately 

recorded; 

(iii) Allocation of the fund level NAVs to individual investors; and 

(iv) Preparation and distribution to investors of statements that detail 

their current NAV and other related financial data. 

(d) The Manager should implement an annual process to produce its 

annual financial statements and related footnotes, which will be 

audited by the fund’s independent accounting firm; 

(e) The Manager should implement an annual process to produce investor 

level tax information, as needed by investors, in accordance with the 

regulations promulgated by the relevant taxing authority; and 

(f) The Manager should periodically assess its operational controls in 

light of the changing needs of its business, particularly where there 

have been changes to the activities of the organization. 

2. Responsibility for any outsourced parts of the process continues to lie with 

the senior management or its designees. 

VII. Disaster Recovery/Business Continuity 

1. To mitigate financial loss in the event of disaster or other business 

disruption, the Manager should establish a comprehensive Business 

Continuity/Disaster Recovery plan. The Plan should include a business 

impact analysis to identify and prioritize critical processes for the 

Manager. It should also clearly articulate business recovery and 

resumption objectives. This plan may include written procedures and 

documentation, test plans and test scenarios as well as other procedures for 

addressing unforeseen events in an emergency. 
 41 

2. Business continuity planning should cover all operational business 

functions and should not be limited to technology-based disaster recovery 

plans.9

 

9

 Additional guidance on the development of disaster recovery/business continuity planning is 

provided in the Managed Funds Association’s 2007 Sound Practices for Hedge Fund 

Managers. 
42 

Compliance, Conflicts and Business Practices 

Compliance, Conflicts and Business Practices Framework 

A Manager should establish a comprehensive and integrated compliance and business 

practices framework that is supported by adequate resources. The goal of the framework 

is to provide guidance to the Manager and its personnel in respect of ethical, regulatory 

compliance and conflict of interest situations. Critical to the success of the framework is 

a strong culture of compliance. 

The framework should include: 

1. A written code of ethics that establishes principles governing the conduct 

of the Manager’s personnel; 

2. A written compliance manual that addresses (i) the various rules and 

regulations governing the Manager’s operations; (ii) potential conflicts of 

interest that may arise in the course of those operations; and (iii) the 

maintenance and preservation of adequate records; 

3. The establishment of a Conflicts Committee to review conflicts; 

4. Regular training of personnel on the material elements of the compliance 

program; and 

5. A compliance function that includes (i) a Chief Compliance Officer to 

monitor and maintain the Manager’s compliance program; (ii) appropriate 

discipline and sanctions to address departures from the Manager’s 

compliance program; and (iii) an annual review of the Manager’s 

compliance program.

I. Culture of Compliance 

1. Critical to the success of the compliance and business practices framework 

is a culture of compliance, grounded in the commitment and active 

involvement of the most senior leaders of the firm and fostered throughout 

the organization. 

2. Particularly important to creating a culture of compliance are the 

following: 

(a) Encouragement by senior management to personnel to raise any 

concerns or questions (facilitated by an environment that is free from 

fear of retribution); 

(b) Ability to communicate concerns to senior management; 
43 

(c) Active participation by senior management in compliance meetings 

and training sessions; 

(d) The role of the Chief Compliance Officer (or other person with similar 

responsibilities) should be regarded as institutionally significant; and 

(e) Senior management should consult regularly and encourage employees 

to consult regularly with the Chief Compliance Officer and his or her 

delegates whenever issues arise that could raise compliance issues. 

3. Maintaining high ethical standards of integrity in the Manager’s business 

must be the responsibility of senior management and each employee. 

II. Code of Ethics 

1. The Manager should develop and adopt a written code of ethics that 

establishes guidelines that are designed to foster integrity and 

professionalism among the Manager and its personnel and its commitment 

to act in the best interests of the fund. Whether particular policies or 

subjects are addressed in the code of ethics or compliance manual 

(discussed further below in sub-section III) should be determined by the 

Manager taking into account what it believes is most effective for its 

business. 

2. These guidelines should address, at a minimum, the following issues, to 

the extent relevant to the Manager’s structure and operations: 

(a) Standards of conduct that require the Manager’s personnel to operate 

with integrity and professionalism; 

(b) The fiduciary capacity of the Manager and its personnel (including the 

priority of the interests of the fund and its investors over the interests 

of the Manager and its personnel); 

(c) Protection of confidential information about the fund and its investors 

and any such information received by the Manager from third parties; 

(d) Personal trading by the Manager’s personnel; 

(e) The receipt or provision of gifts and entertainment; 

(f) A review or approval process for considering the compatibility of 

personnel’s internal role with outside directorships and other business 

interests; 

(g) An internal reporting mechanism for conduct inconsistent with the 

code of ethics; and 
44 

(h) Other policies that the Manager considers appropriate given its 

particular characteristics and operations. 

3. The code of ethics should apply to all employees. To the extent that 

certain policies do not apply, or apply differently to certain types of 

employees, depending on the nature of their responsibilities, duties and 

access to information, the Manager should clearly identify the types of 

employees (for example, investment professionals) to whom those policies 

apply. 

4. The code of ethics should reflect the nature of the Manager’s business. 

While “off the shelf” codes or manuals may provide useful background 

and guidance, the code should be appropriately adapted to fit the 

Manager’s business. 

5. Employees should certify that they have read the code of ethics and that 

they will act in conformity with it. 

III. Compliance Manual 

A. General Elements of the Compliance Manual 

1. The Manager should evaluate the critical elements to be addressed in its 

compliance manual in light of the focus of, and conflicts relating to, its 

business and operations. 

2. The Manager should develop a written compliance manual that outlines its 

policies and procedures for complying with laws, rules and regulations 

(domestic or international) applicable to the fund’s business operations 

and trading activities. 

3. The following are topics that a Manager should consider addressing in its 

compliance manual (to the extent relevant): 

(a) Marketing and Communication: 

(i) Procedures for communicating with third parties (including 

media communications); 

(ii) Procedures for using third-party marketers to solicit investments, 

where this practice is permitted; and 

(iii) Procedures for review of any marketing materials used by the 

Manager, including review of performance presentation 

standards. 
45 

(b) Anti-Money Laundering:10

(i) Anti-money laundering policies and procedures and compliance 

with the Bank Secrecy Act, as applicable, such as: 

● Procedures for identifying investors prior to subscription and 

periodic review of the fund’s investor base; and 

● Where anti-money laundering compliance is delegated to an 

administrator or other third-party, periodic review of the 

delegate’s practices (including its consistent application of 

those practices). 

(c) Trading and Business Practices: 

(i) A procedure for the prompt and accurate recording of 

transactions; 

(ii) Trade allocation policies, such as policies in respect of 

allocations among funds and managed accounts or proprietary 

accounts, where applicable; 

(iii) A procedure for proxy voting; 

(iv) A trade error policy; 

(v) A best execution policy that includes selection criteria for 

executing brokers, and provides for identification and review of 

such criteria by a best execution committee (where applicable) 

or by senior management;

(vi) A policy for the use of soft-dollar arrangements and bundled 

commissions that may include: 

● Review of the Manager’s use of soft dollars for consistency 

with the practices outlined in disclosure to investors or 

compliance with Section 28(e) of the Securities Exchange 

Act of 1934 (where applicable); and 

● Heightened review of transactions with affiliated brokerdealers (where applicable) to monitor that the use of soft 

 

10 Additional guidance is provided in Appendix IV of the Managed Funds Association’s 2007 

Sound Practices for Hedge Fund Managers. 
46 

dollars is consistent with what has been disclosed to 

investors. 

(vii) Policies prohibiting manipulation, such as: 

● Prohibition of late trading or market-timing; 

● Prohibition of front-running; 

● Prohibition of spreading of false rumors and wash sales, as 

appropriate in light of the Manager’s business; 

● Procedures for hedging and short sales in connection with 

offerings of securities (such as in connection with PIPE 

transactions); and 

● Procedures for participating in new issuances of securities 

and complying with representations to brokers regarding 

eligibility for such issuances. 

(viii) Policies and procedures to prevent, detect, and address the 

misuse of material non-public information and insider trading 

(including in respect of price- or market-sensitive information 

and confidential information obtained from brokers, consultants 

or other third parties), which may include the use of information 

barriers, restricted lists or other appropriate procedures; 

(ix) Policies and procedures designed to prevent obtaining material 

non-public information while conducting research and 

information gathering when investing in public companies; 

(x) Policies and procedures for personal trading by personnel of the 

Manager, such as identifying Manager personnel subject to 

restrictions and establishing appropriate procedures to control 

that trading (e.g., mandatory pre-approval or clearance of certain 

transactions and investments in initial public offerings or private 

placements, prohibition of or restriction on trading certain types 

of investments, restricted lists, black-out periods and holding 

periods); and 

(xi) Policy on compliance with securities law ownership reporting 

requirements, such as the Hart-Scott-Rodino Antitrust 

Improvements Act of 1976, Sections 13 and 16 of the Securities 

Exchange Act of 1934, short sale reporting and comparable nonU.S. reporting requirements. 
47 

(d) Surveillance:

(i) The Manager should establish a system to monitor compliance 

with its compliance policies and procedures; and 

(ii) Appropriate surveillance will vary with the nature of the 

Manager’s activities and the characteristics of the fund, but 

should include review of records or other documentation 

produced in the ordinary course of business that can be useful in 

assessing the Manager’s compliance with its policies. 

B. Recordkeeping

1. Business records that are important to the Manager and fund should be 

maintained. Examples include contracts, constituent documents, trade 

data, accounting records, documents relating to valuation, records of 

meetings of any principal committees (such as the Risk, Valuation, and 

Conflicts Committee), investor communications and correspondence. The 

Manager should establish policies and procedures for the creation, 

maintenance and retention of business records that are appropriate to its 

size and level of activity. These policies and procedures should focus on 

key business records and should address, where applicable: 

(a) The duration of retention, which may vary by type of record; 

(b) The manner of retention, which should protect against unauthorized 

alteration or untimely destruction; 

(c) Communication of the retention policy to all employees as it applies to 

them; 

(d) Accurate and complete recording of trading activities; and 

(e) Methods to access documents retained pursuant to the policy. 

C. Conflicts of Interest 

1. Conflicts are inherent in the asset management business as in many other 

financial services businesses. The key to appropriately handling conflicts 

is to have a process in place for identifying them and addressing them. 

The types of conflicts that may exist in a Manager’s business will vary 

based on its structure, the structure of its funds and the types of activities 

that it conducts. 

2. The following are types of potential conflicts that may be applicable to a 

particular fund and that a Manager should consider in light of its business: 
48 

(a) Conflicts between the Manager and its fund(s), such as: 

(i) Conflicts arising from proprietary trading or proprietary holdings 

in specified investments; 

(ii) Conflicts arising from the valuation process; 

(iii) Conflicts relating to the allocation of costs and expenses 

between the Manager and the fund; 

(iv) Conflicts relating to transactions or business arrangements with 

affiliates, such as brokerage arrangements, cross-trades, 

principal trades and the provision of any other services by 

affiliates; and 

(v) Conflicts relating to relationships with third-party service 

providers (e.g., prime and other brokers, vendors and 

administrators), such as the use of soft dollars, capital 

introduction and consulting services or use of affiliated brokers 

or custodians. 

(b) Conflicts between funds managed by the same Manager or between 

funds and separate accounts managed by the same Manager (e.g., 

conflicts in the allocation of investment opportunities); 

(c) Conflicts between employees (including family members) of the 

Manager and the fund, such as: 

(i) Conflicts arising from personal trading (including frontrunning); 

(ii) Conflicts arising from private investment activities; 

(iii) Conflicts arising from outside business activities; and 

(iv) Conflicts arising from the receipt or provision of gifts and 

entertainment. 

(d) Conflicts between investors, such as conflicts arising from side letters 

or parallel managed accounts that may grant preferential terms to 

certain investors or adversely impact others. 

3. The Manager should adopt policies and procedures to identify and address 

potential conflicts of interest that may arise in its specific businesses. 

Whenever a conflict can be mitigated or addressed in a consistent and 

standardized way (such as in relation to personal trading policies), the 

Manager should adopt policies and procedures to deal with that conflict. 
49 

Recognizing that circumstances may require a review of specific facts and 

that not all potential conflicts can be predicted, the Manager should also 

establish a Conflicts Committee. 

(a) The purpose of the Committee would be to assess new or potential 

conflicts, as they arise, that have not previously been addressed. 

(b) The Committee should also determine whether amendments or new 

policies are necessary or appropriate in light of its review. 

(c) The Committee may include the Manager’s Chief Compliance Officer 

and other members of senior management (as appropriate to the 

internal organization of the fund). 

(d) The Committee should review at least annually the effectiveness of the 

Manager’s conflict management process. 

(e) The Committee should keep appropriate records of how material 

conflicts were addressed. 

D. Training and Educating Manager’s Personnel 

1. The Manager should establish a robust training program to educate 

personnel in respect of its compliance program. This training program 

should be developed in light of the following considerations (to the extent 

relevant): 

(a) Training should foster an understanding of all parts of the compliance 

framework; 

(b) Training should be tailored to the type of business undertaken by the 

Manager and should incorporate examples relevant to that business. It 

should focus on identifying compliance issues particular to the 

Manager’s operations and on preventing market abuse; 

(c) At least annually the Manager should organize and make available to 

personnel performing a significant business function a compliance 

training session addressing topics identified by the Chief Compliance 

Officer and by employees as relevant to the activities of such 

employees. The Manager may enlist the services of outside experts, 

such as outside counsel, to conduct these sessions; 

(d) Training should address circumstances where it would be appropriate 

to seek guidance from the Chief Compliance Officer or other member 

of senior management regarding a compliance matter; and 
50 

(e) Because junior personnel will often develop greater compliance 

awareness through open and informal discussions with their 

supervisors and the Chief Compliance Officer, such contact should be 

encouraged as part of the training process. 

IV. Compliance Function 

1. The Manager should establish and devote adequate resources to a 

compliance function to oversee, implement and review the Manager’s 

compliance program. 

A. Chief Compliance Officer 

1. A Chief Compliance Officer or other member of senior management (as 

appropriate to the size, complexity and resources of the Manager), with 

sufficient knowledge and experience, should be appointed to oversee the 

Manager’s compliance program. 

(a) The Chief Compliance Officer’s duties may include: 

(i) Identifying compliance risks (in consultation with other senior 

personnel); 

(ii) Monitoring compliance with policies and procedures; 

(iii) Conducting an annual review and assessment of the Manager’s 

compliance framework (including the compliance manual); and 

(iv) Providing for staff awareness of the Manager’s compliance 

policies and procedures through training and other methods 

appropriate for the Manager’s business. 

(b) The Chief Compliance Officer should have adequate resources to seek 

the advice of external experts on compliance matters when needed. 

This may be especially important where the Manager operates in 

international markets outside the location of the Manager. 

(c) The Chief Compliance Officer should be able to devote sufficient time 

to the performance of his or her functions. 

(d) Employees should report all compliance matters to the Chief 

Compliance Officer or other designated staff. 

2. In addition to a Chief Compliance Officer, other members of senior 

management may be appointed to oversee compliance in specific areas. 
51 

B. Discipline and Sanctions

1. Non-compliance with the policies or procedures described in the various 

parts of the compliance framework should be reviewed and handled 

promptly and conclusively. To this end, policies and procedures may 

provide for the following:

(a) Non-compliance with the code of ethics or compliance manual should 

be internally reported to the Chief Compliance Officer according to the 

reporting procedures stated in these documents. 

(b) Disciplinary responsibility generally lies with senior management. 

Accordingly, the Chief Compliance Officer should have access to and 

report to senior management and should recommend appropriate 

disciplinary action to senior management.

(i) The Chief Compliance Officer or General Counsel should 

conduct an internal review of allegations or evidence of 

wrongdoing, as necessary; and 

(ii) A range of sanctions may be appropriate for non-compliance, 

such as (depending on the severity of the infraction and an 

employee’s compliance history) reprimands, censure, 

suspension, termination and, where applicable and practical, 

restitution and disgorgement of profits.

C. Annual Compliance Review 

1. The Manager’s compliance framework, including compliance policies and 

procedures, should be reviewed at least annually to assess its 

effectiveness. A more frequent review of aspects of the compliance 

framework is appropriate upon the occurrence of events that necessitate 

more immediate changes. Each component of the compliance framework 

should be reviewed by the Chief Compliance Officer in light of significant 

changes and factors relevant to the Manager’s business, such as: 

(a) Legislative and regulatory developments; 

(b) Changes in business practices; 

(c) Variations in the Manager’s strategies and products; 

(d) The growth of the Manager’s business; and 

(e) Employee conduct.