SEC Changes May Slow Down Hedge Fund Regulation

by Leroy James, Investors Offshore, New York

08 November 2002

The departure of Harvey Pitt, chairman of the SEC, has prompted speculation that the SEC's moves towards greater regulation of the hedge fund sector may be slowed or halted. The SEC launched a study of the hedge fund sector last May, concerned about hedge fund fraud, erroneous valuations and misrepresentation to investors. The agency sent extensive questionnaires to large numbers of US hedge funds, and is now studying the information collected.

Although Harvey Pitt has paid the penalty for mis-handling the appointment of a head of the new Accounting Oversight Board, succumbing to a strident chorus of protest from a number of quarters, he began with an extensive slate of reforms in mind, and was to the fore in wanting to place greater controls on free-wheeling hedge funds, along with the Treasury. But his perceived lack of independence from the administration was one of his weaknesses, and a new SEC chairman may have a more pro-capital agenda, even if he isn't allowed to say so out loud.

"Hedge funds have been used as the whipping boy in other parts of the investment world, and I expect this rush to scrutinize and perhaps regulate them will die down soon," said Joe Nesler to Reuters. He leads the hedge fund division at Chicago law firm Gardner, Carton & Douglas. "Harvey Pitt was going along with the probe because that's the way the political winds were blowing," Nesler said.

Currently, hedge funds are not obliged to report to the SEC, or to register, although there is a voluntary scheme under which registration carries some privileges in terms of marketing freedoms. Only a small minority of hedge funds have taken up voluntary registration. The SEC hasn't revealed its plans, but warnings about hedge fund risks from Harvey Pitt and Paul Roye, the SEC's director of investment management, have caused unease among hedge fund managers

Lawyers tracking events at the SEC expect a recommendation that hedge fund managers should be required to register as investment advisors under the Investment Advisers Act. This could be easily done by changing Rule 203(b)-1, which currently has the effect of exempting hedge funds. Under the Act, which dates from 1940, the SEC could restrict the fees hedge funds charge and audit them occasionally, as well as limiting or banning some of their investment techniques.

However, only minor frauds have surfaced at hedge funds. This year, the SEC has shut down some smaller funds for illegally soliciting retail investors and then 'investing' the proceeds in personal goods.

"After people start looking into these things closely, there is always the brush fire to regulate. But it is not a huge area of problems and it raises the question of whether it is worth devoting public resources to this issue," Nesler said.

Hedge fund managers are resigned to greater regulation, but they are still siding with St Augustine: 'God make me chaste - but not yet!'

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