SEC proposes limited registration for hedge fund managers

(July 16, 2004) A year after convening a two-day conference on hedge funds, the U.S. Securities and Exchange Commission (SEC) has tabled a proposal to force hedge fund managers to register with the commission.

In part, the proposal reflects the fact that the SEC knows so little about hedge funds. The proposal “would provide the commission basic, vital information about the hedge fund industry that we simply do not have today,” said SEC chair William Donaldson at a commission meeting this week.

He reiterated that argument later in testimony before the U.S. Senate Committee on Banking, Housing and Urban Affairs. “The ability to oversee the increasing number of hedge fund advisors more effectively, through the registration process, would give the agency a much-needed and more complete picture of the key players in our securities markets.”

Increasingly, hedge funds are becoming mass market products in the U.S. Donaldson notes that there now 40 funds of funds registered with the SEC, with investment minimums of $25,000 rather than the more usual $1 million. “Funds of hedge funds raise special concerns because they permit investors to invest indirectly in the very hedge funds in which they likely may not invest directly,” Donaldson says.

Investors may have other indirect exposure. Donaldson estimates that 20% of corporate and public pension plans use hedge funds.

Apart from the growing share of hedge funds in the investment marketplace, Donaldson also cites the role of hedge funds — all unregistered — in the market-timing and late-trading scandals. Other abuses include overstatement of performance, payment of unnecessary and undisclosed commissions, and arbitrary valuations of assets. About 80% of the 46 hedge fund fraud cases before the SEC involved unregistered advisors, Donaldson notes, adding “the frauds we see in hedge funds are not unique to hedge funds.” Still, in the absence of registration, the SEC is hindered in its ability to detect fraud.

However, two of the SEC’s five commissioners oppose mandatory registration, and John Gaine, president of the Managed Funds Association, a U.S. trade group, says, “Any resort to governmental regulation has to be carefully considered to ensure that the benefits afforded outweigh the burdens created. The case for mandatory investment advisor registration of hedge fund managers has not been made, and we expect that, once all the facts are in, the proposal will not be adopted.”

The SEC’s proposal would not require registration of hedge funds, but of their advisors. That would enable the SEC to collect data and conduct examinations of the advisors’ activities, Donaldson says. The proposals would also only apply to managers with more $25 million under management.

One upshot of registration would be to force hedge funds to have a compliance officer, as well as policies and procedures. But the SEC’s chief investment funds’ officer Paul Roye argues that these procedures should already be in place, since unregistered advisors are still subject to the SEC’s anti-fraud provisions.

Filed by Scot Blythe, Advisor.ca, scot.blythe@advisor.rogers.com.

(07/16/04)