SEC To Monitor Hedge Funds' Activities

by Mike Godfrey, Tax-News.com, Washington

16 July 2009

Continuing its push to establish new rules and make the financial system fairer across the board, the US Department of the Treasury has delivered proposed legislation to Capitol Hill to require all advisers to hedge funds and other private pools of capital, including private equity and venture capital funds, to register with the Securities and Exchange Commission.

A statement from the US Treasury noted that prior to the economic crisis, the United States experienced an explosive growth of a variety of privately owned investment funds. The crisis, it considers, triggered significant strain on financial markets because several funds reduced their leverage. In order to create greater stability in financial markets, the US Treasury considers that reliable, comprehensive data is now necessary to monitor funds’ activity and assess potential future risks to the market. It believes that its proposals will help protect investors from fraud and abuse, while providing increased transparency, as well as providing the US government information it now deems necessary in order to assess whether risks in the aggregate, or risks in a particular fund, pose a threat to the overall financial stability.

The SEC will require advisers to private investment funds to register with the SEC. Although some advisers to hedge funds and other private investment funds are required to register with the Commodity Futures Trading Commission (CFTC), and some register voluntarily with the SEC, current law generally does not require private fund advisers to register with any federal financial regulator. The Administration's legislation would, for the first time, require all investment advisers with more than USD30m of assets under management to register with the SEC. Once registered with the SEC, investment advisers to private funds will be subject to important requirements such as:

• Substantial regulatory reporting requirements with respect to the assets, leverage, and off-balance sheet exposure of their advised private funds;
• Disclosure requirements to investors, creditors, and counterparties of their advised private funds;
• Strong conflict-of-interest and anti-fraud prohibitions;
• Robust SEC examination and enforcement authority and recordkeeping requirements; and,
• Requirements to establish a comprehensive compliance program.

The SEC will monitor hedge funds for potential systemic risk. Under the Administration's legislation, the regulatory requirements mentioned above would include confidential reporting of amount of assets under management, borrowings, off-balance sheet exposures, counterparty credit risk exposures, trading and investment positions, and other important information it deems relevant to determining potential systemic risk and potential threats to overall financial stability. The legislation would require the SEC to conduct regular examinations of such funds to monitor compliance with these requirements and assess potential risk. In addition, the SEC would share the disclosure reports received from funds with the Federal Reserve and the Financial Services Oversight Council. This information, the Treasury disclosed, would help determine whether systemic risk is building up among hedge funds and other private pools of capital, and could be used if any of the funds or fund families are so large, highly leveraged, and interconnected that they pose a threat to our overall financial stability and should therefore be supervised and regulated as Tier 1 Financial Holding Companies.

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