Hedge Fund Compliance. Scharfman Jason А.

      Take, for example, trade allocation, in which a hedge fund manages two different funds that adhere to primarily the same investment strategy. Each fund has been created to accommodate the tax needs of different types of clients (onshore and offshore). When funds are managed in this structure they are said to be managed in what is known as a pari passu manner.2 One fund is structured for clients who are typically based in the same country as the headquarters of the hedge fund. This is known as the onshore fund. The other fund is for investors based outside of the primary country in which the hedge fund operates. This is known as the offshore fund. Funds organized in this manner typically are structured to sit beneath what is known as a master fund that coordinates the underlying funds trading activities. In this structure, the onshore and offshore fund would be referred to as feeder funds, and the entire fund complex would be a master‐feeder structure. Assume that our master fund makes a single purchase of 100 shares of Google stock. Typically, the stock would not remain at the master fund and would need to be allocated between the onshore and offshore feeder funds. But how should this allocation be completed? You might think it would be easiest to split the shares 50–50 among the two funds. Perhaps, however, the onshore fund contributed more of the capital to make the purchase happen and trade should be allocated in a method known as pro‐rata trade allocation, which means that the trades should be allocated proportionally. Or what if the fund manager intended to buy more shares, or perhaps even all of the shares just for the onshore fund alone?

      Alternatively, consider whether the performance of the offshore fund has been slightly worse as compared to the onshore fund. If this is a winning trade, then perhaps the fund manager would wish to boost the performance of this poor performing fund by allocating more shares to it. While benefiting the offshore investors, this would disadvantage the onshore investors.

      It is the role of a hedge fund's compliance function to design the policies with regard to the way trades are allocated and to oversee the implementation of these policies in conjunction with investment personnel. In such an example, the compliance function would be tasked with playing an active role in overseeing that the allocation of trades among the funds is conducted in an manner that does not unfairly disadvantage the funds investors and complies with regulatory guidelines as well as the fund managers own internal policies.

      Compliance plays a role in overseeing these types of activities. For example, if the prospective client is a government employee, there may be limits to the value of any gifts or meals they are allowed to receive. Similarly, to avoid gaining undue influence by service providers through lavish gifts, a hedge fund's own internal compliance policies may limit the value of gifts its own employees can receive.