Compliance manual

A compliance manual acts as the central handbook for a hedge fund's compliance policies and procedures. This document creates the framework that helps hedge funds follow regulations and manage risks. The manual is especially important for hedge funds that register with the Securities and Exchange Commission (SEC) as . However, all hedge fund managers benefit from having clear compliance procedures, whether they register with the SEC or not.

The SEC created , known as the Compliance Rule, which requires registered investment advisers to develop and implement written compliance policies and procedures. These policies must be designed to prevent violations of the and SEC regulations by both the adviser and the people who work for them.

The SEC provides clear guidance on how to design effective compliance programs. Advisers should start by conducting a thorough assessment to identify specific and compliance risks that apply to their business. This assessment should consider the firm's unique business model and client base. After identifying these risks, advisers should then develop compliance policies and procedures that directly address those specific risks. This approach ensures that each firm's compliance framework matches its actual operations rather than using generic policies that might not fit their specific situation.

The SEC expects advisers to address the following areas in their policies and procedures, depending on what applies to their specific operations:

1. Portfolio management and opportunity allocation processes: How the firm distributes investment opportunities among clients and whether portfolio compositions match stated investment objectives, adviser disclosures, and regulatory requirements
2. Trading practices: Best execution protocols, procedures for combining and allocating trades among multiple clients, , , use of affiliated brokers, and how to handle and correct trading errors
3. Proprietary trading activities: Trading done by the adviser itself and personal securities trading by employees and other
4. Disclosure accuracy: Ensuring all information provided to investors, clients, and regulators is accurate and complete
5. Client asset protection: Safeguarding client assets from misappropriation or improper use by firm personnel
6. Record keeping: Proper creation, organization, and maintenance of required records, including protections against unauthorized changes, loss, or destruction
7. Marketing practices: How advisory services are presented to prospective clients, including use of
8. Valuation methods: How client holdings are valued and how advisory fees are calculated based on those valuations
9. Information confidentiality: Protection and security measures for client information and data
10. Business continuity planning: to ensure operations can continue during disruptions
11. Conflict of interest management: How conflicts are managed and disclosed
12. Cybersecurity: Risk management and incident response for cyber threats
13. Client privacy: Safeguards and data protection measures for client information

The SEC's examination staff consistently emphasizes that compliance policies and procedures must be meaningfully customized to each adviser's actual business practices and operations. Using generic, pre-packaged compliance manuals can create compliance violations under Rule 206(4)-7 because these generic manuals fail to address the specific risks and compliance factors unique to each firm.

Examination staff increasingly expect compliance policies to be specific and detailed enough for firm personnel to understand and implement them practically. Vague or overly general compliance policies represent a common and significant problem. The examination staff has also found that advisers frequently struggle to implement the actions their own policies require, maintain accurate and current information within their compliance frameworks, or adequately customize their policies to reflect their actual business operations.

In May 2024, the SEC amended to require all registered investment advisers to develop written policies and procedures for detecting, responding to, and recovering from unauthorized access to or use of customer information. These requirements apply whether the information is stored electronically or in physical format.

Under the amended regulation, advisers must assess cybersecurity incidents and determine whether they need to notify affected individuals. When notification is required, it must occur without unreasonable delay. The notification should provide details about the incident and information to help affected individuals understand and respond appropriately to potential risks. Advisers must maintain written documentation of any detected incidents, their responses, recovery efforts, and decisions regarding notification requirements.

Large entities—advisers with $1.5 billion or more in assets under management—must comply with these Regulation S-P amendments by December 3, 2025. Advisers with smaller asset levels have until June 3, 2026 to comply. The amended regulation significantly expands the definition of information requiring protection, so compliance manuals should address the broader scope of "customer information" and establish clear protocols for incident management and reporting.

policies are typically included as a core component of the adviser's compliance manual, with all employees responsible for following these policies. A , often the same individual serving as the AML Compliance Officer, coordinates the overall AML program and serves as the primary contact for AML-related issues. While the AML Compliance Officer may delegate certain routine operational duties to internal staff or external service providers, this delegation does not eliminate the officer's or the firm's ultimate responsibility for maintaining an effective AML program.

A fund's legal counsel plays a critical role in advising on federal and state securities law compliance matters. Counsel typically drafts the compliance manual, assists with other internal compliance policies and procedures, and may prepare the firm's regulatory filings. These filings include and required position reports such as , , , , and submissions.

For hedge funds with international operations, compliance manuals must address the regulatory requirements of applicable foreign jurisdictions. In the United Kingdom, the Financial Conduct Authority (FCA) requires that firms maintain a written compliance framework tailored to their business model and implement a compliance-monitoring program to verify that the firm actually follows its stated compliance procedures. Firms should regularly evaluate their business activities to identify potential regulatory concerns and develop appropriate responses to those concerns.

The compliance manual documents the firm's intended approach to regulatory compliance. While firms may occasionally deviate from documented procedures while still maintaining overall compliance, such deviations could themselves be considered non-compliant if they reflect inadequate compliance frameworks. The FCA emphasizes that compliance manuals should not be treated as static documents but rather as living frameworks subject to ongoing review and updating.

Effective compliance manuals require regular updates to reflect changing regulations, business practices, and industry developments. Key implementation considerations include:

Regular training programs to ensure staff understanding and adherence, periodic testing and monitoring of compliance procedures, documentation of compliance activities and any identified deficiencies, annual reviews and updates to maintain currency and effectiveness, and clear assignment of responsibilities and accountability for compliance functions.

The compliance manual serves as both a regulatory requirement and a practical tool for managing operational and legal risks. It helps hedge funds maintain high standards of conduct while protecting investor interests and firm reputation. SEC examination staff consistently review compliance manuals as part of their examination process, looking for evidence that policies are reasonably tailored to the firm's business, properly implemented, and regularly updated to address evolving risks and regulatory changes.