Key Elements of a Hedge Fund Adviser Business Continuity Plan

The credit crisis changed the nature of institutional investor due diligence of hedge fund managers.  While performance remains a critical diligence point, aspects of the hedge fund advisory business other than performance now play a more prominent role in the investment decision-making process of institutional investors.  See “How Can Start-Up Hedge Fund Managers Use Past Performance Information to Market New Funds?,” Hedge Fund Law Report, Vol. 2, No. 50 (Dec. 17, 2009).  The idea is that even hedge fund managers with years of competitive fund performance and deep benches of investment talent can be laid low by inadequate risk management, compliance and controls.  Galleon is the paradigmatic example.  See “Best Practices for a Hedge Fund Manager General Counsel or Chief Compliance Officer that Suspects or Discovers Insider Trading by Manager Employees or Principals,” Hedge Fund Law Report, Vol. 2, No. 48 (Dec. 3, 2009).  One element of hedge fund adviser infrastructure that has received significant attention of late from institutional investors (as well as regulators) is the business continuity plan (BCP).  Broadly, as the name implies, a BCP is a written plan (often included in the compliance manual) in which a hedge fund manager identifies the range of events and risks that can interrupt business operations and investment activities, and details the steps that the manager will take if those events or risks come to fruition.  Events that may trigger the procedures in a BCP can be natural (e.g., hurricanes, earthquakes, pandemics), man-made (e.g., terrorism, theft, other crimes) or technological (e.g., power outages, disruption of exchanges, computer viruses).  And the procedures used to address those risks must be tailored to the manager’s strategy, technology, network of service providers and geographic location.  Moreover, the BCP has to be a living document – something that is tested, communicated to employees and other constituents, and updated as relevant.  It cannot be boilerplate: at this point, institutional investors have seen a healthy number of BCPs, and they will know when they see a BCP that reflects inadequate customization – and that can make the difference between investment and non-investment.  This article offers a comprehensive analysis of BCPs in the hedge fund context, as well as reporting from a recent webinar on the topic hosted by hedge fund technology firm Eze Castle Integration and prime broker Pershing Prime Services.  In particular, this article: defines a BCP more particularly; enumerates key elements of a hedge fund manager BCP (including, among others, development of an impact analysis, communications plans, backup facilities, coordination with third-party service providers and succession planning); and discusses: the impact of a hedge fund’s strategy on its manager’s BCP; regulatory requirements, including what the SEC looks for with respect to BPCs in the course of inspections and examinations; institutional investor expectations; disclosure considerations; communicating a BCP to hedge fund manager employees; and the frequency with which a BCP should be reviewed and updated.  This article is the first in a two-part series.  The second article in the series will deal with disaster recovery plans, which are close cousins of BCPs and are outlined in this article.

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