As we and others reported, at an open meeting held on June 22, 2011, the SEC delayed the date by which many hedge fund managers will have to register as investment advisers. The new registration deadline is March 30, 2012. See “SEC Delays Registration Deadline for Hedge Fund Advisers, and Clarifies the Scope and Limits of Registration Exemptions for Private Fund Advisers, Foreign Private Advisers and Family Offices
,” Hedge Fund Law Report, Vol. 4, No. 21 (Jun. 23, 2011). One of the consequences of registration is that registered hedge fund managers will have to designate a chief compliance officer (CCO) to administer their compliance policies and procedures. See “Who Should Newly Registered Hedge Fund Managers Designate as the Chief Compliance Officer and How Much Are Chief Compliance Officers Paid?
,” Hedge Fund Law Report, Vol. 4, No. 7 (Feb. 25, 2011). The rule requiring registered investment advisers to designate a CCO – SEC Rule 206(4)-7 – provides that the CCO of a registered hedge fund manager “should have a position of sufficient seniority and authority within the organization to compel others to adhere to the compliance policies and procedures.” However, the rule does not prescribe any specific institutional designs that would be sufficient to confer the required “seniority and authority” on a CCO. That is, the rule requires a CCO to have authority, but it does not tell hedge fund managers what specific steps to take to ensure that the CCO has such authority. Accordingly, hedge fund managers confronted with a new registration requirement are facing the question that is the title of this article: to whom should the CCO of a hedge fund manager report? The answer to this question has important consequences for the effectiveness of a CCO within a hedge fund management company and for the CCO’s professional security, and is by no means intuitive. Industry practice varies considerably on the topic, though sources interviewed by the Hedge Fund Law Report voiced agreement on certain fundamental principles. This article offers insight on the appropriate design of CCO reporting lines within a hedge fund management company. At a general level, this article addresses two questions: How can CCO reporting lines be structured to protect the management company? And: How can CCO reporting lines be structured to protect the CCO? To address those general questions, this article analyzes: what “reporting” means in the hedge fund context; the benefits and burdens to a hedge fund management company of the typical CCO reporting lines; related industry precedents for CCO reporting; how reporting lines can be structured to protect the CCO; terms that should be included in CCO employment agreements, compliance manuals and codes of ethics to protect the CCO; and the pros and cons of whistleblowing under the recently finalized rule. This article concludes with a ten-step roadmap for reporting that can serve as a template for hedge fund manager CCOs that discover violations or potential violations, regardless of how their reporting lines are structured.