Hedge funds prepare rules to stay out of trouble
By Svea Herbst-Bayliss
NEW YORK, Jan 6 (Reuters) - It's a case of short-term pain for long-term gain.
The normally secretive hedge fund industry is turning the spotlight on itself as its lobbyists prepare a set of guidelines designed to keep would-be money launderers away from the often free-wheeling funds that cater to millionaire individuals and financial institutions.
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Until now, many hedge funds happily accepted money from banks from the Caribbean to Switzerland without asking for details about the source of the money. These banks often draw customers with assurances of bank secrecy and promises never to give out names of people behind accounts.
The Sept. 11 terror attacks and ensuing legislation to crack down on illicit funds has changed that. The new guidelines will likely require that fund managers screen their customers better and report irregularities to authorities.
Rather than sit back and wait for government regulators to tell them what to do, hedge fund promoters are working with authorities with the aim of making sure future laws will be to their liking.
``We have drafted something that could be a component of a broader best practices document and the first part, that would be an identification of customers, might come out in January,'' said Patrick McCarty, general counsel of the Managed Funds Association.
The move comes at a critical time for an industry that is known as much for its out-sized returns as for its spectacular blowups. The industry is experiencing a growth spurt, and funds are swinging open their doors to mainstream investors with deep pockets instead of just catering to the super rich.
Funds may get a first peek this month, but the catalog of suggestions is sure to cause a stir, industry analysts said. They predict it will take months to agree on a set of best practices.
The timing of this effort may seem ironic since it comes just as this industry is experiencing a new growth spurt.
Last year alone, about 1,000 new funds set up shop, swelling the total number of funds to about 6,000. Just as mainstream investors want a piece of these rarefied investment pools, managers are searching the world for new capital.
But questions about who invests where have taken on new urgency, as the U.S. government tracks how certain groups finance their activities. The Sept. 11 hijackers who flew into the World Trade Center and the Pentagon, killing thousands, kept money in U.S. banks. Hedge funds recently came under scrutiny as possible vehicles for criminal money transfers and investments.
These secretive funds often shoulder the blame for market controversy because they operate under special rules, which helped them outperform most stock funds last year, and make them attractive to people who want to stay anonymous.
The fledgling industry, which manages roughly $450 billion, about 1/14 of what the $6.7 trillion mutual fund industry invests, now sees a chance to buff up its image by working closely with regulators to keep money out of the wrong hands.
``Because hedge funds make it their business to stay out of sight, they are often a favorite scapegoat and this is an opportunity to gently get their name in a more positive light,'' said Mark Silber, vice president at hedge fund Renaissance Technologies Corp., which manages about $5 billion.
As a start, the new guidelines will likely urge hedge funds to know their customers better. Like banks, they will be asked to record clients' names, addresses and nationalities and share suspicious information with intelligence agencies.
For hedge funds, which generally have fewer than 100 investors, this would be an easy and obvious way to comply with the so-called Patriot Act, which covers the entire financial services industry. The law was enacted last year to prevent money from being sent to illegitimate groups.
After all, no manager wants to be on the record for inviting money-launderers into a fund.
"I'm not going to manage money for some bad guy," Silber
said.
But many funds fear screening clients could be bad for
business.
Only a handful of funds have put their money where their
mouth is and told clients to identify themselves or risk having their money returned. Silber's fund is one of few that adopted stringent provisions and irritated some clients when it refused to take nominee accounts, which are popular in Europe.
``We will have to adapt our best practices to deal with multiple situations and this is going to have to be a process that will be vetted through funds of different sizes that have different back office capabilities,'' said Paul Roth, partner at Schulte Roth & Zabel, a law firm that represents many hedge funds.
``Fair practices are intended to satisfy people that hedge funds are not and will not become ways in which money can be laundered for those persons who are prohibited from making investments in the United States,'' he said.
Satisfying a wide variety of hedge fund managers that these rules will be beneficial may be a tough sell.
Already, one big sticking point is how far fund managers will have to dig to satisfy themselves that their clients, sometimes big banks or so-called funds of funds, are not consorting with the wrong types.
``Am I going to have to check out every client of every bank who invests with me or will it be enough to have a bank tell me they are satisfied there are no terrorists on board?'' asked one manager, who declined to be identified. ``If I have to put in some huge risk management team to do that, that would outnumber my traders and the costs could kill me.'' |
