US Brokers Told To Vet Hedge Funds And Investors More Carefully

Carla Johnson, Investors Offshore, London

04 March 2003

The National Association of Securities Dealers, which regulates Wall Street brokers, has expressed concern that some brokers are undertaking inadequate due diligence on the hedge funds their clients purchase. The NASD has told its members to ensure that investors are sufficiently sophisticated to understand the risks involved.

"Some advertising material gave us some concern," said Mary Schapiro, vice-chairman of the NASD, "which is largely focused on retail investors' (protection),"
She acknowledged that the NASD move would have broader ramifications for the hedge fund marketing business, which has become a significant source of revenue for its promoters. One of the effects could be to make buying into funds more costly for investors.

Smaller brokerages that have recently moved into the so-called 'capital introduction' business, and who had increased fund promotion and marketing in the market downturn may be more affected than established players, for whom the NASD move is expected to have less of an impact. Brokers such as Goldman Sachs, Morgan Stanley and Deutsche Bank, who can match hedge funds and investors as a way of generating business for prime brokerage operations, which in turn provide investment trading services to the funds, will continue to see their hedge fund operations as part of their overall business.

The NASD's action may owe a lot to activity at the Securities and Exchange Commission, the lead US securities regulator, which conducted extensive enquiries into hedge fund activity last year, and is known to be preparing a radical overhaul of hedge fund regulation, including possible limits on the funds' ability to "short" stocks and curbs on stock borrowing.

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