A new separate section on transactional practices that includes discussion of soft-dollar arrangements, plus expanded coverage of internal trading and risk controls, valuation, and responsibilities to investors are among the updates in the Managed Funds Association’s 2005 Sound Practices for Hedge Funds publication.

The MFA released this new version of sound practices for hedge funds on Tuesday [Aug. 2], just days after the Counterparty Risk Management Policy Group II encouraged hedge fund managers to adopt them as part of a best-practices regime for transparency, risk management, market discipline and financial stability.

The new sound-practices guide updates the previous version, issued in 2003. The recommendations in it are designed to promote “sound businesses practices” among hedge fund managers and “enhance investor protection while contributing to market soundness,” according to the MFA.

“Our latest Sound Practices offer a ‘peer to peer’ perspective for hedge fund managers providing a framework for internal practices and controls,” said Stephanie Pries, vice president and senior legal counsel at the MFA, in a statement. “It establishes standards of excellence for single-manager hedge fund operations. We cover new ground on issues of great importance, such as hedge fund manager compliance manuals and codes of ethics, disclosure to investors, best execution and soft dollars.”

Soft dollars get special and extended treatment in the 2005 Sound Practices. A separate section on Transactional Practices was broken out from the Regulatory Controls section this time around, and in it the MFA addresses soft dollars, along with best execution and agreements between counterparties.

The MFA sound practices recommend that hedge fund managers develop policies relating to the use of products and services paid for with soft dollars, and that they disclose those policies to investors. For instance: “. . . [A] Hedge Fund manager should develop policies related to Soft Dollar Arrangements, including the proper allocation of products or services with mixed uses (i.e., computer hardware that assists an adviser in research functions and in non-research functions) so that non-research services are paid for out of the Manager’s own funds, and the proper allocation of ‘step-out’ arrangements.”

According to the MFA, step-out arrangements allow a hedge fund manager to execute trades through a broker that provides that provides best execution, and still pay commissions to other brokers from which it receives research or services through soft-dollar arrangements.

Hedge fund managers should disclose to investors that they may use soft-dollar arrangements and make available the specific policies governing those arrangements, including the kinds of products and services paid for with soft dollars. Soft-dollar policies should include procedures and documentation requirements for third-party arrangements, according to the MFA.

Other sections in the sound practices guide touch on management and internal trading controls, responsibilities to investors, valuation policies and procedures, risk monitoring, regulatory controls, and business continuity and disaster recovery. MFA President John G. Gaine said the association kept in mind as it drafted the sound practices that no “one size fits all” solution exists for all hedge fund managers or their funds.

“We drafted our recommendations with enough specificity to provide meaningful guidance, but recognize it is impossible to provide guidance suited to all hedge fund managers,” Mr. Gaine said in a statement.

On the web: Managed Funds Association.