U.S. legislators set sights on hedge funds

The days of footloose and fancy-free hedge funds may be nearing an end. A movement is afoot by both U.S. legislators and regulators to force hedge funds to comply with a greater range of securities laws.

Erik R. Sirri, director of the U.S. Securities and Exchange Commission’s Division of Market Regulation, testified before the Financial Services Committee of the U.S. House of Representatives. Sirri explained to the committee that the SEC is looking at ways to improve the regulation of hedge funds to increase transparency and reduce fraud.

“In general, the growth in private pools of capital, such as hedge funds, has made the financial markets wider and deeper, supported significant product innovation, and allowed for greater risk transfer. At the same time, this development has created numerous challenges for regulated financial institutions and their supervisors,” Sirri told the committee.

Sirri explained that the primary issue the SEC has had in regulating hedge funds is that its advisors are often exempt from registering with the regulator under the current provisions of the Investment Advisers Act of 1940. In 2004, the SEC tried to make it mandatory for certain hedge fund advisors to register with the SEC and therefore be subject to its regulations.

However, a court decision, Goldstein v. SEC, overturned the rule because it was determined that under the Investment Advisers Act, investors were not the clients of hedge funds advisors. Instead, the pool of capital the hedge fund advisor oversees was deemed to be the client, thus allowing the exemption from SEC regulations.

Sirri says that as of Wednesday, the SEC is proposing to adopt a new set of regulations that will make it illegal for hedge fund advisors to mislead or make false statements to the investment pool.

American legislators in both the House and Senate have determined that is not good enough. They are looking to change the wording of the Investment Advisors Act and have forwarded three bills in as many months that would change the definitions of law as they apply to hedge funds and would therefore allow the SEC to exercise more authority over them.

A bill introduced in the Senate in May and one in Congress in June both propose changes to the wording so that effectively hedge funds would have to register with the SEC.

Another bill introduced in Congress last month would force pension plans to disclose all of their investments.

SEC officials will also testify at a simultaneous hearing into the legality of private equity IPOs on Wednesday and Thursday.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com