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Risk

All companies, including funds and their advisers, incur risk as a part of doing business. The primary business of a fund is investment management, and in order to achieve investment returns, a fund must incur investment risks. Boards have a general oversight responsibility to oversee both a fund’s investment risks and its business operational risks.

Derivatives

One specific type of investment risk that has drawn the attention of many, including the SEC and CFTC staffs, is the risk associated with a fund’s use of derivatives. Board oversight of derivatives is generally the same as it is for other portfolio investments and directors are not expected to be experts in this area or to micromanage a fund’s use of derivatives. Rather, board oversight of the use of derivatives includes working with the adviser to be sure that the board receives meaningful, understandable, and organized risk-related information. Further, a board typically engages in discussions with the adviser about the following:

to learn more
Read the IDC task force paper Board Oversight of Derivatives.
  • types of derivative instruments in which the fund may invest, the investment rationale for using these instruments, and the potential benefits and risks associated with their use;
  • expertise and experience of the adviser and relevant service providers with respect to derivatives investments as well as their operational resources, internal controls, and organizational structures; and
  • policies and procedures designed to identify and control risks associated with derivatives investments, including protocols for routine and event-related reporting to the board.

Operations Risk

Another category of risk that funds face is business operations risk, which arises from the business of running a fund. It captures the risk of loss arising from an external event or internal failure of people, processes, or systems, and includes compliance, information technology, and human capital risks.

Fiduciary Duty to Oversee Risk

A fund board oversees the management of all of these and other risks as part of its general fiduciary duties and oversight responsibilities. Neither the 1940 Act nor any SEC rules contain specific provisions that require a fund board to engage in risk oversight. The SEC requires, however, that funds disclose in their registration statements “the extent of the board’s role in the risk oversight of the fund, such as how the board administers its oversight function and the effect that this has on the board’s leadership structure.”

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