Financial industry scandals uncovered during the past year and a half have led to calls from regulators and institutional investors for the unbundling of services that, in some cases, have been performed under the roof of a single hedge fund manager.  On the regulatory side, the most salient example is the recently amended custody rule.  As the SEC said in its adopting release, although the amendments do not require the use of an independent custodian, the SEC “encourage[s] custodians independent of the adviser to maintain client assets as a best practice whenever feasible.”  (We covered the custody rule amendments last week, and will have significantly more to say about them in coming weeks.  See “SEC Adopts Investment Adviser Custody Rule Amendments,” Hedge Fund Law Report, Vol. 3, No. 1 (Jan. 6, 2010).)  On the institutional investor side, the most noteworthy development along these lines has been the increasing volume and frequency of calls for independent hedge fund administration.  See “Implications of Demands by Institutional Investors for Independent Hedge Fund Administrators,” Hedge Fund Law Report, Vol. 2, No. 3 (Jan. 21, 2009).  The basic idea underlying calls for such unbundling is that the provision of administration, custody and similar services by third parties will diminish the ability of hedge fund managers to engage in fraud and, in less extreme scenarios, will mitigate conflicts of interest.  For example, if Custodian X has custody of the assets of Fund Y and sends account statements to investors in Fund Y, the manager of Fund Y will have a difficult time persuading those investors that the fund contains assets that do not exist.  Similarly, if Administrator X calculates the net asset value (NAV) of Fund Y and shares that NAV with investors in Fund Y on a monthly basis, the manager of Fund Y will have a difficult time selling inflated NAV figures to investors.  While the case for third-party administration is plausible – and indeed various leading hedge fund managers have acceded to demands from institutional investors for third-party administration – there remain compelling counterarguments in favor of in-house administration.  Two of the most compelling such arguments involve cost and complexity.  That is, third-party administration generally is paid for by the fund, so in-house administration can save costs.  Also, some managers, especially those with more complex strategies, have invested significantly in the people, processes, technology and infrastructure that comprise their in-house administrative function.  From the perspective of such managers, converting to third-party administration would constitute a step down in terms of expertise and would undermine the value in a large, long-term investment.  (While some of that value can, in theory, be recouped by selling the in-house administrative unit as a separate entity, the unit may be so integrated into the manager’s operations that such a spin out is not practicable.)  Since money-raising remains challenging, and calls for third-party administration remain stentorian, this article aims to elucidate the pros and cons of third-party administration versus in-house administration for various categories of hedge fund managers.  Specifically, this article discusses: what specific services hedge fund administrators perform; typical fees for administrators; relevant considerations when selecting a third-party administrator; the case for in-house administration; the case against in-house administration; and the treatment of administration under the EU’s proposed AIFM Directive and in Luxembourg.  Perhaps most importantly, this article highlights a compromise solution that may enable hedge fund managers to perform in-house administration while addressing the underlying concerns that cause institutional investors to demand third-party administration.