SEC tightens hedge fund scrutiny
By Jeremy Grant in Washington
Financial Times
Updated: 10:40 p.m. ET Sept 21, 2006
The Securities and Exchange Commission is tightening scrutiny of hedge funds by stepping up examination of the links between hedge funds and broker-dealers, particularly where they are owned by a hedge fund, a senior SEC official said.
The move is a sign that the SEC continues to find ways to regulate hedge funds after a US court federal court in June overturned an SEC rule forcing hedge fund advisers to register with the agency.
Walter Ricciardi, deputy director of enforcement, said: "I think some of the problems we've seen with hedge funds, one of the risk factors, red flags, is where they have their own broker-dealer.
"That creates quite a conflict in the sense that investors' money is sitting there and a hedge fund decides to trade through their own broker-dealer and [the hedge fund] get a fee for such trading.
"It gives them an incentive to run up trading fees. It may not be in the best interests of investors," he told the Financial Times.
While the SEC's office of compliance already conducts routine inspection of broker-dealers, Mr Ricciardi said the enforcement division – which is focused on alleged wrongdoing in the securities markets – was "stepping up [the focus] on hedge funds".
The SEC took similar steps in the wake of the collapse of Long Term Capital Management in 1998.
The timing of the fresh scrutiny comes as Amaranth Advisors, a hedge-fund manager that lost about $4.6bn in the past month, has become the second largest hedge fund loss since LTCM.
Last week, SEC enforcement chief Linda Thomsen said the SEC had used similar tactics to unearth evidence about late trading and market timing in mutual funds by hedge funds.
"The regulated entities [broker-dealers] are our window into hedge funds," she said.
"Everybody's doing business with them. We're going to find out what they're doing through what we can see."
Mr Ricciardi said that hedge funds' fee structures might have "attracted some miscreants". "Probably the vast majority of hedge fund managers are very honest traders but in any environment where there is that much money and that much incentive to cheat you're going to have some bad apples," he said.
The types of issues that the SEC had seen revolved around evidence that trades might not have occurred, even though they were being recorded as having taken place, he added.
"You have statements coming from the hedge fund to investors and there may not be sufficient controls over that process. We've seen some instances where it's just a phoney statement and the investments shown on the statements do not exist.
"A good question to ask is whether there are third party administrators to check to see that the investments are real and properly priced," Mr Ricciardi said.
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