Hedge Funds To Undergo Regular Inspections Under Tougher SEC Regime

by Leroy Baker, for LawAndTax-News.com, New York

31 January 2006

With the deadline for hedge funds to register with the Securities and Exchange Commission set to expire tomorrow, a senior SEC official has revealed that hedge funds, particularly those considered by the regulator to be high risk, can expect regular inspections from compliance officers.

According to a report in the Financial Times, Gene Gohlke, the SEC's associate director of compliance, has said that hedge funds whose businesses are deemed high risk will face inspections at least once every three years, while low risk hedge funds which registered with the SEC may face inspections at random.

In an effort to make the burgeoning hedge fund industry more transparent and to reduce the chances of fraud, the SEC has changed the definition of a "client" under the Investment Act of 1940 so that hedge funds managing more than $30 million in assets with more than 15 clients will be obliged to register as investment advisers.

Previously, hedge funds could skirt the registration rule because they counted each fund under their management as a single client, rather than numbering each fund's individual investors.

Between 700 and 800 hedge funds are expected to have registered with the SEC come Wednesday's deadline, and by Thursday of last week, 113 hedge funds based outside United States had registered, the FT reported.

However, many hedge funds will be watching with interest the progress of a challenge to the SEC's rule brought by the New York hedge fund manager Phillip Goldstein who believes that the regulator has gone beyond its powers with its decision to introduce the new rule.

Last month, Circuit Judge Harry Edwards of the US Court of Appeals for the District of Columbia told the SEC that its argument for hedge fund registration "doesn't hold up".

"You can't just come in here and say we're going to make 'client' mean whatever we want because we're the agency. We have to test your thesis and your thesis doesn't stand up," Judge Edwards remarked.

In response, SEC lawyers contend that the definition of a "client" under current legislation is too vague, and this makes it "permissible" for the regulator to rewrite the rules.

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