Hedge Fund Advisor Supports SEC Over Accredited Investors

by Phillip Morton, Investors Offshore.com

22 March 2007

Hennessee Group LLC, an adviser to hedge fund investors, has come out in support of recent actions by the US Securities and Exchange Commission to increase the accredited investor level, and has recommended further consideration of rules covering industry “gatekeepers".

Charles Gradante, Managing Principal of the Hennessee Group, states that “the increase in personal household wealth, inflation and economic growth since 1982, when the accredited investor level was enacted, in and of itself points to the need to increase the accredited investor level. Additionally, we at the Hennessee Group also support the ‘gatekeeper’ approach to monitoring systemic risk and enhancing investor protection.”

Mr Gradante has testified before the SEC, the Commodities and Futures Trading Commission, the House of Representatives and the Senate Banking Committee on investor protection and systemic risk.

Hennessee is of the view that, despite the recent decision not to directly regulate hedge funds, proactive indirect monitoring through coordination with “gatekeepers”, including prime brokers, accountants, administrators, investment banks and commercial banks (many of which are already under regulatory oversight or influence), can be a cost-effective alternative.

According to Hennessee Group research, the largest 100 hedge funds account for more than 50% of the industry’s total assets, and pose the greatest threat with regard to systemic risk.

Gradante further stated that “the 100 largest hedge funds should be given the equivalent of ‘CUSIP numbers’ to track their activity through prime brokers and commercial banks, who in turn would report data to regulators, the Treasury, and the Fed. This would allow significant transparency into the use of leverage and potential systemic risk”.

Most hedge fund leverage comes from two regulated sources: investment banks and commercial banks, both of which are regulated and can report leverage to regulators and government agencies.

Hennessee Group research also shows that over 90% of US hedge funds currently utilize one of 10 prime brokers, who are registered broker dealers and regulated by the SEC and NASD. Information about leverage and concentration can be gathered from this source.

Hennessee argues that the following mandates would be an improvement for purposes of investor protection: monthly or quarterly third-party administrator services for domestic hedge funds to independently compute net asset values (NAV); and requiring accounting firms to send K-1 statements and annual audits directly to the limited partner, and not through the general partner.

To establish a level playing field for all investors, including retail investors who want to invest in hedge funds, the mandate for the new class of mutual funds that are currently permitted to replicate a long/short managed fund should be broadened, Hennessee said. In this way, the retail investor would receive the regulatory protection imposed by the Investment Company Act of 1940 while achieving the benefits of diversification.

In addition, Hennessee notes that over 90% of all US hedge funds use one of six accounting firms to perform annual financial audits, and more than half of US offshore hedge funds currently use one of the top five administrators. The uncertainties about the size of the hedge fund industry (in assets and leverage) can be answered by polling these accounting firms, the company said.

Hennessee concluded that by capturing information from the “gatekeepers,” regulatory authorities and government agencies can increase transparency of the $1.442 trillion hedge fund industry in a cost-effective and timely manner, without inhibiting the entrepreneurial spirit of the industry that provides liquidity, contrarian research and pricing efficiency to the markets.

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