SEC Not Prepared for the Registration Flood?

Hedge fund managers continue to procrastinate with February deadline approaching

NEW YORK (HedgeWorld.com)--Hedge fund managers are still procrastinating when it comes to registering with the Securities and Exchange Commission, but the SEC also may be lagging in its preparedness, according to one consulting firm.

After a brief analysis of completed registration statistics through Sept. 5, Carbon360 predicts that the SEC will be caught off guard in the coming months, as the number of registration applications swells to unprecedented levels with hedge funds rushing to beat the Feb. 2006 deadline to register as investment advisers.

Only a portion of the hedge fund universe has registered with the U.S. regulator--213 managers to be exact, which would be a far cry from the 50% of the hedge fund industry that SEC officials claim to have already processed.

The SEC's New York and Boston offices, which oversee New Jersey and Connecticut respectively in addition to those cities' states, will likely be the hardest hit; Carbon360 estimates that another 1,900 managers will begin the registration process shortly.

"It doesn't take much to look at the tea leaves," said Brian Shapiro, president of Carbon360, a research and advisory firm that works with hedge fund managers.

So far many of the industry's recognizable names have yet to hit the Investment Advisory Registration Depositary, which is the electronic filing system used by managers to register with the SEC.

Still, there may some variables at play. Many larger firms are thought to have increased their lock-up periods to two years in order to avoid registration. Mr. Shapiro believes that for the most part those hedge fund managers are not as concerned with the rigors of registration as they are with liquidity issues, and they are more interested in keeping the majority of assets invested rather than in cash reserves held in case of large investor redemptions.

Taking into account the number of single managers that may offer single funds or funds of hedge funds with lock-ups of two years or more, Carbon360 is standing by its initial estimate of 1,900 hedge fund managers registering with the SEC for the first time.

"Given that filings are averaging about 100 a month, we would expect the SEC to be flooded with new registrants come December or January as managers rush to make the deadline," Mr. Shapiro said.

SEC has said that it expects to see an 8% to 15% increase in its pool of registered investment advisers thanks to its new hedge fund rule that requires most funds to register. The agency already oversees 9,025 asset managers. Carbon360 officials found the increase in registrants measured against the universe of managers will actually be in the range of 22%.

The flood of registration applications may end up being approved by default, since the SEC and its Division of Investment Management have 45 days to review and deny a registration request. If they choose to not take action, the manager automatically becomes registered, Mr. Shapiro said.

New registrants should expect an initial examination or audit within the first year, with the largest investment managers becoming subject to review every one to two years after that under the SEC's assumption that they pose a greater risk to a greater number of investors. This may mean that the smaller managers that historically have been the source of SEC litigation industry may not be getting the attention that they deserve, according to Carbon360.

The SEC is under a time crunch and has been forced to focus in on firms it determines are high risk through examination sweeps, similar to what some hedge fund firms saw earlier this year. Such sweeps help examiners weed out the firms at risk for foul play, the regulators say.

Mr. Shapiro sees potential problems. "How adequately are they defending investors if they too are overwhelmed?" he asked.

The new hedge fund registrants will translate into the need for at least 316 more staff people to handle initial examinations of the new registrants, according to Mr. Shapiro. The SEC will be short 193 examiners, according to Carbon360's analysis of the SEC's 2006 congressional budget request. which totals an all-time high of US$888 million.

SBarreto@HedgeWorld.com

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