Hedge fund body worried by sweetened client deals

Tue Apr 13, 2010 11:19am EDT

* HFSB worried by rise in use of side letters

* May ask managers to spell out special terms to all clients

* Still no regulatory requirement for disclosure

By Laurence Fletcher

LONDON, April 13 (Reuters) - A heavyweight hedge fund industry group has voiced concerns about preferential deals offered to some investors and may ask member firms to bolster disclosure to other clients of the risks the practice poses. Antonio Borges, chairman of the Hedge Fund Standards Board (HFSB), told Reuters it was "worrisome" that more and more hedge funds were giving some clients so-called "side letters".

These separately-negotiated agreements, which have attracted the attention of the UK's Financial Services Authority (FSA) in recent years, offer different investment terms to certain clients, some of which could disadvantage other investors.

"It's happening more than before," Borges said. "It's worrisome... The worries are that some investors get better terms at the expense of others if there are side letters."

Borges said some investors legitimately require different terms, but said others investing money into the industry as it recovers from the credit crisis are negotiating more favourable terms than other clients, who may not be aware of this.

The terms included in side letters can offer preferential access to cash or rebates on fees. Firms can also signal they may waive notice periods for redemptions, potentially giving a client an advantage if there is a sudden run on a fund.

"We're in the early stages of debating (it)," he said. "Member firms (of the HFSB) are debating with investors these issues."

Hedge fund managers are not formally required to disclose side letters, although the FSA has said that it believes that failing to disclose material side letters "would be a breach of our regulatory requirements".

Industry body AIMA (the Alternative Investment Management Association), in conjunction with the FSA, has published best practice guidelines, which say managers should disclose terms that give some investors better access to their cash.

However, one lawyer at a London-based firm who works with the hedge fund industry told Reuters that these guidelines aren't strictly followed by all managers.

The lawyer said many managers use broad, generic phrasing to tell investors that it may grant side letters.

Borges told Reuters the HFSB, which sets a strict code on issues such as valuation and risk management for about 60 percent of Europe's hedge fund industry, could ask members to simplify offer documents or their risk reporting to clients.

Such moves could mean that members have to spell out to investors the preferential terms that some clients have, or else explain why they are not doing so.

The HFSB already requires member firms to have adequate processes to avoid conflicts of interest.

"One possibility is that you have some kind of standardised offer document to investors or standardised risk reporting," said Borges. "Documents could be simpler ... and may or may not include special provisions (to investors)." (Editing by David Cowell) (To read the Reuters Funds Blog click on blogs.reuters.com/fundshub; for the Global Investing Blog click here)