SEC Staff Formalizes Hedge Fund Recommendations

>Paramount among the SEC recommendations was a requirement for hedge fund managers to register with the regulatory body as investment advisers.   This move would make hedge funds subject to regular SEC inspections and examinations, according to a Reuters report.

“The staff further recommends that the commission consider amending its rules to require that registered hedge fund advisers file … a disclosure statement specifically designed for hedge fund investors,” the SEC staff said in a report to the SEC’s five-member commission.

This would put hedge funds more on par with mutual funds, which, like hedge funds, pool money from investors and invest it.  However, unlike mutual funds, hedge fund investors generally do not receive the full protection – such as disclosure of fund information – afforded other investments under federal and state securities laws.  Differenitation would still exist as missing from the report though was any requirements calling for the registration of hedge funds themselves.

>The staff also said that registration of hedge fund advisers “would effectively increase the minimum investment requirement for direct investments in certain hedge funds.”    At present, only individual investors with net worth of at least $1 million or annual income of at least $200,000 for two consecutive years are eligible to invest in hedge funds.

Hedge Exams

Hedge funds, which have opened up their traditional market of institutional and wealthy investors to include smaller entities, are largely unregulated and have seen their share of criticism from not only the SEC but other public officials as well (See    CA Comptroller Calls For Hedge Fund Disclosure).   Until recently, the problem was concentrated among the upper crust of the investment world within the ranks of the “qualified investor.”  However, the advent of funds of hedge funds has opened the door to smaller investors, offering lower minimum entry requirements than traditional hedge funds, such as $25,000 compared with $1 million. 

This led the SEC to express concern about the $600-billion hedge fund industry earlier this year in the form of an investor warning (See  SEC Issues Hedge Fund Investor Warning ) and through comments made by SEC Chairman William Donaldson at a public roundtable on the hedge fund industry.  At the roundtable discussion, Donaldson said the agency’s probe of the industry had highlighted worries about “potential conflicts of interest, questionable marketing tactics, valuation concerns and market impact of hedge-fund strategies.”

The SEC staff’s suggestions in the report will face tough review by the fund industry and the public, as well as the five-member commission itself, which is divided on approaching the matter.