June 30, 2006

SEC to Probe Side Letters

The issue of “side letters,” the practice of favoring certain investors over others, is rearing its ugly head in the world of hedge funds. Following allegations that most hedge funds indulge in the exercise, the US Securities and Exchange Commission (SEC) is contemplating punitive action against the perpetrators. While side letters are not totally illegal, hedge funds are duty-bound to be fair to all their investors, said Marco Masotti, a partner at the law firm Paul, Weiss. MSNBC reports:

Side letters might give an investor exclusive information about the fund's portfolio, a fee reduction, or more flexible redemption terms. In the UK, the Financial Services Association recently warned hedge funds about the use of side letters, saying if they were used at all, they should be disclosed to all investors.

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