SEC Proposes New Oversight on Hedge Funds
07.14.2004, 12:05 PM
The Securities and Exchange Commission proposed Wednesday to clamp new oversight on hedge funds, traditionally investment pools for the wealthy that regulators said are growing and largely unregulated.
The vote was 3-2. It was the second time in less than a month that the SEC split over a significant regulatory move, with SEC Chairman William Donaldson and the two Democratic commissioners opting for stricter regulation while his two fellow Republican members opposed it.
On June 23, the panel voted in the same fashion to mandate that mutual fund boards have chairmen who are independent from the companies managing the funds - an action that will force an estimated 80 percent of U.S. mutual funds, or some 3,700 funds, to replace their chairmen.
This time, the SEC approved a proposed new rule ordering most hedge fund managers to register with the agency. If formally adopted after a public comment period, the rule would open the funds' books to SEC examiners and make them subject to an array of regulations including accounting and disclosure requirements.
The agency could, for example, conduct inspection "sweeps" of groups of hedge funds, something it now lacks legal authority to do.
The high-risk, potentially high-return funds, have an estimated $750 billion to $1 trillion in assets and are growing, and oversight is needed to head off potential blowups that could hurt ordinary investors, SEC officials say.
"Small investors are increasingly being exposed to the risks of hedge fund investing," Paul Roye, head of the SEC's investment fund division, said at a public meeting. He said the agency "needs to detect and prevent fraud at an earlier stage, and prevent these fraudulent activities from damaging markets and harming average investors. ... In most of the hedge fund fraud cases we have seen, the (SEC's) involvement began long after investors' assets were gone."
The two Republican commissioners, Paul Atkins and Cynthia Glassman, have publicly expressed opposition to the proposal. But the two Democrats on the panel supported it along with Donaldson.
After being opened to public comment for several months, it could be formally adopted by the SEC.
"I fear that we are setting off down the road of regulatory overreaction," Atkins said at the meeting. "Fraud deterrence is a laudable goal, but so is avoiding regulatory overreach."
Tighter regulation of the funds also is strenuously opposed by other policymakers, notably Federal Reserve Chairman Alan Greenspan, who maintains that it would hinder the flexibility of financial markets.
Still, a number of hedge fund managers - representing some 40 percent of those in the United States - have voluntarily registered with the SEC, many of them in recent months since Donaldson and other officials began discussing the issue.
Critics of stricter oversight say that institutional investors and sophisticated, wealthy individuals are aware of the risks and don't need the protection of federal regulators.
Furthermore, under the current system, "the SEC can prosecute any (hedge) fund for fraud if it wants to," said Meg Bode, a spokeswoman for the Managed Funds Association, whose members include investment managers for hedge funds.
The SEC says it has seen an increase in fraud among the 5,700 or so hedge funds in the United States, and has brought 40 enforcement cases against them in the last five years, able to act only after investors have lost money.
One hedge fund, Canary Capital Partners, is at the center of the scandal engulfing the $7 trillion mutual fund industry. Regulators have accused Canary of securing special trading privileges at several big-name mutual fund companies, including Bank of America, Banc One, Janus and Strong.
Hedge funds traditionally have been investment outlets for the wealthy and for sophisticated investors. But to attract smaller investors, funds of hedge funds - which invest in several hedge funds rather than individual securities - have sprung up since 2002 and offered lower minimum entry requirements than conventional hedge funds, such as $25,000 compared with $1 million.
Beyond being lured into a hedge fund, ordinary investors also passively participate in them through their pension funds and 401(k) retirement plans - which are increasingly putting billions into hedge funds.
Like mutual funds, hedge funds pool investors' money to try to earn the highest return possible. But hedge funds can use techniques that are off-limits to mutual fund managers, such as shorting stocks, essentially betting they will fall, and using derivatives - complex financial instruments used to hedge against risk.
__ |
