SEC Investigation Likely To Pave The Way For Hedge Fund Regulation
The massive Securities and Exchange Commission investigation of the hedge fund industry launched by Chairman Harvey Pitt in May could yield results by the end of the year and pave the way to regulating these unregulated firms. Lawyers closely observing the SEC's activities in this area said last week they anticipated the Commission staff will recommend in a report to be drafted in coming weeks that hedge fund managers should be required to register as investment advisors under the Investment Advisers Act. The sources said that to crack down on hedge fund fraud, one step the SEC could take would be to amend the custody rule to cover hedge funds.
"I hear the staff is under the gun to finish the review by the end of the year," said Barry Barbash, now a partner in Shearman & Sterling and formerly director of the SEC's Division of Investment Management. "By then they will have some kind of game plan. To conclude [that] the SEC is thinking in terms of regulation doesn't seem to me off the mark." He pointed out that bringing hedge funds under the IAA could be done in a short time by changing Rule 203(b)-1. As currently written, it has the effect of exempting hedge funds.
SEC officials are not saying much. But Brian Bullard, chief accountant in the IM Division, did tell a mutual fund industry meeting on Sept. 25 "We're really trying to determine...whether it's time for the Commission to potentially consider some sort of regulatory scheme for hedge funds...The Commission has not considered anything specifically and the staff will continue to do these examinations for the next month or so." During the summer, agency staff subpoenaed large amounts of information from hedge funds. Last week, legal sources said some responses have already come back to the SEC and others are expected shortly. An SEC spokeswoman said "staff work continues," and declined to elaborate.
John Baker, partner at Stradley, Ronon, Stevens & Young, said he wouldn't be surprised if the staff issues a report by Dec. 31. He said the Commission wants to impact hedge fund problems in three areas--misappropriation, erroneous valuations and misrepresentation to investors. Extending last summer's proposed custody rule for advisers to hedge funds would reach the first two of these, he pointed out. "The omission [of hedge funds from the custody rule as originally proposed] is questionable," Baker commented. "In light of the number of high-profile frauds committed in recent years against hedge funds with audited financial statements [audits were the justification for exempting hedge funds in the rule as proposed in July]...A rigorous custody requirement would provide assurance to private fund investors substantially greater than that given by an audit and should reduce the number of fraud cases." |
