Why Funds Should Confirm Clear Contractual Obligations and Liabilities With Their Administrators

In recent years – following the Madoff scandal and the corresponding increase in regulatory scrutiny of hedge funds – investors have increasingly pressured managers to hire third-party fund administrators. See “Implications of Demands by Institutional Investors for Independent Hedge Fund Administrators” (Jan. 21, 2009). Administrators add an extra layer of review and verification to mitigate the insularity and lack of oversight that allowed Madoff’s fraud to flourish undetected for decades. Notwithstanding the critical role that administrators play in the financial services industry, they are not subject to the same level of regulatory oversight as other service providers, such as a fund’s prime broker or auditor. Accordingly, when an administrator’s processes break down, causing losses directly to the fund and indirectly to its investors, the fund’s only option may be to pursue a civil action against the administrator. The success of such a claim will then depend on not only the facts of the case, but also the provisions setting forth the administrator’s obligations and liabilities contained in the agreement between the fund and the administrator. In a guest article, Lisa Solbakken, a partner at Arkin Solbakken, provides insight on the proper role of the administrator, details ongoing litigation in which funds allege that their administrators breached their contractual duties to the funds and offers advice on how funds should approach the negotiation of their administration agreements. For more on administrator liability, see “‘Gatekeeper’ Actions by the SEC and Investors Against Administrators Challenge Private Fund Industry” (Sep. 8, 2016). 

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