Allocation of Trades Continue to Vex Hedge Funds
The allocation of trades has always been an area of concern to hedge funds. The issue is whether a manager is breaching its fiduciary duties by favoring one fund or account over another. The reason this issue is so problematic is that it is so hard to define. For example, consider these scenarios:
*If a manager’s funds have different investment objectives or risk profiles - is there any reason for a manager to be concerned about trade allocations?
*What constitutes a “better investment” or “being favored” - is it always just a mathematical computation as to which investments provided a greater return?
*What are the manager’s obligations in terms of monitoring and documenting trade allocations? Particularly for funds that are frequent traders — does trade allocation need to be constantly monitored and documented?
*What if a manager decides not to make an investment for a particular account - is there any way in which that decision could be considered “favoring” that account? What circumstances would make it possible to prove that negative inference?
The trade allocation issue has always been one that the SEC has looked at in its exams, and it is also often the focus of litigation. Within the hedge fund industry, monitoring of the allocation of trades is becoming an increasingly sophisticated exercise, with a variety of forensic testing methods being utilized. Developing an appropriate system for monitoring is a key component of any good compliance program.
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