With speculation rife that hedge funds will become subject to mutual fund–style regulation and all that that would entail, some managers are voluntarily establishing independent ethics boards.
“There is a feeling that if the industry gets ahead of regulation, it may not end up being mandatory,” says Mitchell Nichter, a partner in the San Francisco office of law firm Paul, Hastings, Janofsky & Walker.
At hedge fund firms that have had ethics boards for a while, like New York–based Paulson & Co., the liquidity crisis has forced those committees to play bigger roles, says Steven Nadel, a partner in the hedge fund practice of New York–based law firm Seward & Kissel.
“There is a current shift from ethics or ‘conflicts’ boards focusing on simple matters such as approving principal transactions to instead developing policy to sort out issues that have emerged due to liquid investments turning illiquid, as well as managing the rights of exiting investors against those of remaining investors,” Nadel says. “In many instances some managers have made well-thought-out, good-faith decisions but have nevertheless angered one investor or another.”
Paul Hastings’ Nichter says ethics boards vary widely in the power they wield but that they typically follow one of three models. One requires managers to submit questions concerning certain issues — like investor relations, conflicts of interest, political activity and due diligence and transparency — and binds them to do what board members say. Another demands that managers submit questions but leaves them free to either follow the board’s advice or ignore it. A third model allows managers to decide when to raise an ethics question but makes it mandatory for them to abide by whatever the ethics board decides.
Should the trend toward ethics boards persist, the days of hedge funds’ opting out of having one may well be over.
