Hedge Fund Compliance Chapter 7: The Documents Every Hedge Fund Needs
Previous chapters talked about the people and systems behind hedge fund compliance. Chapter 7 shifts focus to paperwork. And yes, I know paperwork sounds boring. But here’s the thing: without proper documentation, a hedge fund’s compliance program basically does not exist. At least not in the eyes of regulators.
Let me walk you through what Scharfman covers.
Why Write Anything Down?
You might think that if a hedge fund follows the rules, that should be enough. But no. There are good reasons to put everything on paper.
First, regulators require it. Depending on the country, there are specific documents a hedge fund must maintain. In the US, the SEC requires registered hedge funds to have a compliance manual. If you don’t have one, you are already breaking the rules.
Second, employees need a reference. Every fund is different. You cannot just tell people the rules once over coffee and expect everyone to remember. Written policies make it clear what people should and should not do.
Third, investors want to see it. When investors do their homework before putting money into a fund, they want to check the compliance setup. Written documents make that possible. Existing investors may also check back later to see if anything changed.
Fourth, management oversight. The Chief Investment Officer, the COO, outside compliance consultants, fund directors - all of them need to review compliance. Written documents give them something concrete to look at.
And fifth, tracking changes over time. Compliance is not static. Rules change, strategies change, people change. A written record creates an archive. You can see what was in place last year versus now.
What Are the Goals?
Scharfman breaks this into two main goals.
Goal one: meet minimum regulatory requirements. For example, US SEC Rule 206(4)-7(b) under the Investment Advisers Act of 1940 says hedge funds must review their policies annually to check if they are adequate and effective. If a fund does not document this review, they are not compliant. Simple as that.
Goal two: show how things actually work. This means laying out the specific steps employees should take. What forms do they fill out? How do they get pre-clearance for personal trades? These details often live in appendixes to the compliance manual. Many funds now put them on internal websites for easy access.
Different Countries, Different Rules
Here is something important: compliance documentation varies by jurisdiction. A fund in Hong Kong has different requirements than one in London. If a hedge fund operates in multiple countries, it might even have two separate compliance manuals, one for each location. Employees follow the local manual for jurisdiction-specific rules and the firm-wide manual for everything else.
That said, some things are universal. Whether you are in the US or Singapore, best practice says you should have a personal account dealing program. The specific rules around it may differ, but having one at all is expected everywhere.
The Boilerplate Problem
Here is where it gets interesting. Many hedge funds use what is called “boilerplate documentation.” This is off-the-shelf, generic compliance documents that are not written for any specific fund. They come from service providers, lawyers, or consultants.
Using boilerplate as a starting point is fine. The problem comes when a fund buys these documents and never customizes them.
Risk one: too vague. If the compliance manual is full of generic language, employees will not find useful guidance. Investors reviewing the fund will not learn anything. And regulators might notice that the described practices do not match reality.
Risk two: too specific for the wrong fund. Boilerplate documents are often written for large funds. When a small three-person fund uses one, it might describe biannual disaster recovery testing that nobody at the firm actually does. Now you have what Scharfman calls the policy/practice gap: a disconnect between what the documents say and what actually happens. That gap can get you in trouble.
The fix? Take the boilerplate, customize it to match your real practices, and close the gap.
The Core Documents
Now let’s look at the actual documents. Here are the big ones.
The Compliance Manual
This is the centerpiece. Think of it as the main rulebook. A typical table of contents includes things like:
- Introduction and identification of the CCO
- Disclosure and risk assessment policies
- Portfolio management and trading practices
- Valuation and fee policies
- Insider trading prevention
- Safeguarding client assets
- Media relations and advertising rules
- Privacy policy
- Conflicts of interest
- Business continuity and disaster recovery
- Books and records requirements
- Electronic communications policy
- Political contributions
- Annual review procedures
That is a lot. And it should be. This document covers every major area of compliance.
Code of Ethics
Also called a code of conduct. This is a friendlier, less technical version of the compliance manual. It is written so employees can actually read it without falling asleep. Some funds combine the compliance manual and the code of ethics into one document. Others keep them separate.
Stand-Alone Policies
Sometimes a topic is too detailed for the main manual. So funds create separate documents. Common examples:
Best execution policy covers how the fund gets the best deal when trading. Not just the cheapest price, but also speed, quality, and broker research value. The fund reviews its brokers at least once a year.
Soft-dollar policy deals with commission credits that brokers give back to funds. These credits can be used for research services. But this creates a conflict of interest because the fund might pick brokers based on kickbacks rather than what is best for investors. The policy spells out approval processes, criteria, and quarterly reporting.
Trade allocation policy addresses how investments are split among different funds managed by the same firm. The goal is fairness. Most funds try to allocate on a pro-rata basis.
Trade error policy lays out what happens when mistakes occur. Errors must be documented, corrected quickly, and reported to the CCO. You cannot move an error trade to a different client’s account.
Anti-money laundering (AML) policy outlines how the fund prevents dirty money from entering. Many funds delegate this to fund administrators, but the CCO still must evaluate whether the administrator is doing a good job.
Other Policies
Scharfman lists even more: anti-bribery, gifts and entertainment, market rumors, whistle blower protection, risk policies, valuation, custody, privacy, cybersecurity, data backup, social networking, and phone recording policies. The list is long.
Some policies are jurisdiction-specific. In Europe, the AIFMD requires most hedge funds to have a Remuneration Policy. In the US, funds managing money for pension plans under ERISA need a monitoring policy for that.
Compliance Reaches Beyond Compliance Documents
One more thing Scharfman points out. Compliance does not just live inside compliance documents. It touches marketing presentations, due diligence questionnaires, audited financial statements, client reports, and investment research memos.
For example, marketing materials need the right disclaimers. The compliance team works with legal to make sure they are there. Or when an investment team changes a valuation assumption, compliance makes sure a proper memo is produced documenting the change. These are called “manager marked positions,” and they need a paper trail.
So even documents that are not labeled as “compliance documents” are still shaped by the compliance function.
Chapter Summary
Chapter 7 is about the paper trail. Hedge funds need written documentation for regulatory, employee, investor, and management reasons. The compliance manual is the centerpiece, supported by the code of ethics and various stand-alone policies covering everything from trading to cybersecurity to anti-money laundering.
The biggest trap is using generic boilerplate documents without customizing them. That creates a policy/practice gap that regulators will notice.
And compliance extends its reach beyond its own documents, influencing marketing materials, investment memos, and client reporting too.
Next chapter, Scharfman covers how investors actually evaluate all of this. They collect these documents, review them, and decide if a fund’s compliance program is real or just a stack of paper.
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