The January 2009 Report of the Asset Managers’ Committee to the President’s Working Group on Financial Markets remains one of the most eloquent and credible statements of best practices in the hedge fund industry. That Report emphasized the importance of a culture of compliance to the success of any hedge fund management business. It stated: “Critical to the success of [a hedge fund manager’s] compliance and business practices framework is a culture of compliance, grounded in the commitment and active involvement of the most senior leaders of the firm and fostered throughout the organization. Particularly important to creating a culture of compliance are the following: (a) [e]ncouragement by senior management to personnel to raise any concerns or questions (facilitated by an environment that is free from fear of retribution); (b) [a]bility to communicate concerns to senior management; [and (c) s]enior management should consult regularly and encourage employees to consult regularly with the Chief Compliance Officer and his or her delegates whenever issues arise that could raise compliance issues.” See “President’s Working Group Releases Final Best Practices Reports for Hedge Fund Managers and Investors
,” Hedge Fund Law Report, Vol. 2, No. 5 (Feb. 4, 2009). With growing frequency, hedge fund managers are implementing whistleblower hotlines to help create and demonstrate a culture of compliance. Whistleblower hotlines are telephone numbers (and similar communication channels) that an employee or even a principal of a hedge fund manager or service provider can call to anonymously report violations of law or internal policy by another employee or principal of the hedge fund manager. Such hotlines can help effectuate the goals identified by the Asset Managers’ Committee: encouraging voicing of concerns; minimizing fear of retribution; facilitating communication with senior management; and encouraging consultation with the CCO and his or her delegates. While public companies are required under the Sarbanes-Oxley Act of 2002 to have whistleblower hotlines, hedge fund managers are not legally required to have such hotlines and they traditionally have not. Nonetheless, a growing number of managers are looking to such hotlines as part of a coordinated response to a heightened enforcement environment. See, e.g., “The SEC’s New Focus on Insider Trading by Hedge Funds
,” Hedge Fund Law Report, Vol. 3, No. 22 (Jun. 3, 2010); “Regulatory Compliance Association Hosts Program on Increased Risk for Hedge Fund Directors and Officers in the New Era of Heightened Regulation and Enforcement
,” Hedge Fund Law Report, Vol. 2, No. 50 (Dec. 17, 2009). To assist hedge fund managers in evaluating the appropriateness of a whistleblower hotline to their businesses, this article details: the general goals and purposes of whistleblower hotlines; how such hotlines work in the public company context; the use by private equity fund advisers of such hotlines at their portfolio companies; the mechanics of whistleblower hotlines in the hedge fund context (including who reports, to whom, what is reported, and what actions should be taken in response to reports); advantages and disadvantages to hedge fund managers of implementing hotlines; attorney-client privilege issues as applied to hedge fund managers generally; and attorney-client privilege issues raised by hedge fund manager whistleblower hotlines specifically. Also, this article includes a discussion of the potentially perverse incentives created by Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. A fuller discussion is below, but in brief, that section creates a system of financial incentives and protections for whistleblowers who disclose “original information” about securities or commodities law violations that leads to successful SEC or CFTC enforcement actions. Therefore, Section 922 may give employees of hedge fund managers (and others) a financial incentive not to report misconduct through a hotline established by the manager so as to preserve the originality of the information and the potential for a financial bounty if that information is reported to and used by an agency in a successful enforcement action.