Hedge Fund Compliance Chapter 12: Where Compliance Is Headed Next
This is the last real chapter. Scharfman wraps up the book by looking ahead. What trends are shaping hedge fund compliance going forward? What should people in the industry worry about?
Four big topics come up. Let me walk through each one.
CCOs Are Now Personally on the Hook
For a long time, if a hedge fund broke compliance rules, the fund itself got in trouble. The company paid the fine, the company dealt with the consequences. The Chief Compliance Officer was just an employee doing a job.
That started to change around 2015.
Scharfman describes two SEC cases from that year that made CCOs pay attention. The first one involved BlackRock. A portfolio manager named Daniel Rice was running energy-focused funds at BlackRock. At the same time, he founded his own company called Rice Energy, an oil and gas producer. Rice Energy formed a joint venture with a coal company called Alpha Natural Resources. Guess what happened. Alpha became one of the largest holdings in the BlackRock fund that Rice managed. Obvious conflict of interest.
Here’s the problem. BlackRock’s CCO at the time, Bartholomew Battista, did not report this conflict to the board. The SEC said he caused the fund’s failure to disclose a material compliance matter. BlackRock paid $12 million. Battista personally paid $60,000.
The second case was worse in some ways. SFX Financial, a subsidiary of Live Nation, managed money for professional athletes. The firm’s former president, Brian Ourand, stole about $670,000 from client accounts over five years. Just wrote checks to himself and wired money out. The CCO, Eugene Mason, failed to supervise Ourand, did not review cash flows in client accounts, skipped the annual compliance review, and made a false statement in a regulatory filing. SFX paid $150,000. Mason personally paid $25,000.
These cases sent a clear message. CCOs can be held personally responsible.
But here’s the thing. Not everyone agrees this is fair.
Even within the SEC, there was disagreement. Commissioner Daniel Gallagher actually voted against both settlements. His argument was interesting. He said the rules themselves were too vague for CCOs to follow perfectly. Going after CCOs for unclear rules is not fair. He also worried about a chilling effect. If CCOs know they can be personally punished, they might actually write weaker compliance policies on purpose. Why? Because the more detailed your compliance manual is, the more ways you can be found in violation of it. That is a perverse incentive.
Gallagher also pointed out a real problem for small firms. At smaller hedge funds, the CCO often wears multiple hats. They handle compliance and business functions at the same time. They might end up taking ownership of things that could create personal liability without even realizing it.
Regardless of which side you agree with, the trend is clear. CCOs need to be more careful than ever.
Senior Managers Are Getting More Accountability Too
This is not just about CCOs. The trend is broader. Regulators want to hold senior people personally responsible for what happens at their firms.
The UK took this further than anyone with the Senior Manager Regime (SMR), which took effect in March 2016. Under the SMR, senior managers at financial firms must submit a “statement of responsibility” to regulators. This document spells out exactly what areas each person is responsible for. If regulators find compliance violations in those areas, the responsible person gets the blame. Not just the company.
And you have to keep the filings updated. If your responsibilities change, you have to tell the regulators.
The SMR is overseen by two UK regulators, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). They also put in place a Certification Regime to set basic professional standards for people in key risk functions.
At the time Scharfman wrote this, the SMR mainly applied to banks and credit unions. But the plan was to expand it. Eventually, hedge funds could be covered too.
This is part of a global trend. Similar to what Dodd-Frank tried to do in the US after 2008. The idea is the same everywhere: make individuals own the compliance function, not just the organization.
Insurance Is Becoming a Bigger Deal
With regulators going after individual people and increasing enforcement actions, hedge funds need more insurance. Scharfman covers several types.
The basics first. Every hedge fund carries some insurance that is required by law. Workers’ compensation in New York, for example. If more than 25% of a fund’s assets come from benefit plans like pension funds, ERISA requires a fidelity bond. Some insurance is optional but smart to have, like key person insurance or cybersecurity insurance.
The types that matter most for compliance are Errors & Omissions (E&O) and Directors & Officers (D&O) coverage. These are often bundled together as “professional liability insurance.” They protect key fund personnel when things go wrong. Mistakes, breaches of duty, regulatory actions. These policies can also cover the legal defense costs when regulators come knocking.
Here’s the problem. Insurance policies traditionally exclude coverage if the hedge fund admits guilt. Historically, most SEC settlements used language like “neither admits nor denies.” That kept the insurance coverage intact. But recently, there has been more pressure for firms to actually admit wrongdoing when they settle. If they do, the insurance might not cover the legal costs.
So the industry is caught in a squeeze. More enforcement means more legal defense costs. But if you have to admit guilt to settle, your insurance might not pay. And as insurers face higher potential payouts, they are raising premiums.
This is still evolving. But the direction is clear: compliance-related insurance is getting more expensive and more complicated.
Europe Is Coordinating Its Regulations
Hedge funds are global. They trade in multiple countries, raise money from investors everywhere, and have legal structures spread across different jurisdictions. That means dealing with regulators in many places at once.
In Europe, regulators started working together more closely instead of each country doing its own thing. Sounds like a good idea in theory. In practice, it creates both opportunities and problems.
The Alternative Investment Fund Managers Directive (AIFMD) is a good example. It created a “passport” system where European fund managers could market their funds across most of Europe more easily. That is the good part. The bad part is that non-EU managers found it harder to sell into Europe.
Then came MiFID II (Markets in Financial Instruments Directive II) and MAD/MAR (Market Abuse Directive and Regulation). These brought even more compliance requirements. Under MiFID II, hedge funds in Europe had to start recording more phone calls and emails, follow stricter rules about research commissions, and submit more reports to regulators.
When Bloomberg surveyed fund managers about MiFID II readiness, only 7% said they were prepared. Nearly 50% said they would not be ready by the original deadline. The European Securities and Markets Authority (ESMA) ended up pushing the deadline back by a full year.
Regional coordination means you cannot just worry about one country’s rules anymore. You need compliance systems that work across the entire region.
Chapter Summary
This final chapter covers four trends that are reshaping hedge fund compliance:
CCO personal liability is real. Two 2015 SEC cases showed that compliance officers can be personally fined. There is debate about whether this is fair, but the trend is set.
Senior manager accountability is expanding. The UK’s Senior Manager Regime requires individuals to formally own their compliance responsibilities. Similar efforts are happening globally.
Compliance insurance is getting more important and more expensive. As enforcement increases, so do legal defense costs. But insurance coverage gets complicated when firms have to admit guilt.
European regulatory coordination through AIFMD, MiFID II, and other directives means hedge funds need to think about compliance at a regional level, not just country by country.
The overall message? Compliance is becoming more personal, more expensive, and more complex. For hedge fund professionals, staying ahead of these trends is not optional.
This post is part of a series retelling “Hedge Fund Compliance” by Jason A. Scharfman. I go through the book chapter by chapter, summarizing the main ideas in plain language.
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