Policing Hedge Funds

New anti-fraud rule restores SEC's power to monitor hedge funds

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To restore the SEC's enforcement power in policing hedge funds post the Goldstein ruling, the SEC on July 11 adopted a new antifraud rule under the Investment Advisers Act of 1940 prohibiting advisors to certain pooled investments--like hedge funds, mutual funds, venture capital, and private equity funds--from making false or misleading statements to, or otherwise defrauding, investors or prospective investors in those pooled investments.

SEC Chairman Christopher Cox and the four commissioners unanimously approved the ruling, with Commissioner Annette Nazareth stating that there has been a "gap in investor protection" since a U.S. Court of Appeals overturned the SEC's rule that hedge fund managers must register with the Commission; that ruling is known as the Goldstein ruling.

Robert Plaze, associate director for regulation of the SEC's Division of Investment Management, noted that the court of appeals, when overturning the hedge fund registration rule, actually recommended that the SEC consider adopting the anti-fraud rule. Plaze also noted that the anti-fraud rule would not be onerous to comply with because it "does not create any new obligations" for advisors to pooled investment vehicles.

Meanwhile, the House Financial Services Committee held a hearing the same day in which the President's Working Group on Capital Markets reported on hedge funds and their systemic risks. Committee Chairman Spencer Bachus (R-Alabama), noted in his opening speech that earlier this year "the PWG endorsed an approach to hedge-fund regulation that relies primarily on market pressures and incentives to contain risk. The PWG concluded--correctly, in my view--that market discipline, together with statutory limitations restricting access to hedge funds to wealthy investors, can sufficiently mitigate industry risks. By emphasizing the importance of free market forces rather than the heavy hand of excessive government regulation, I believe that the PWG has struck the right balance in regulating the activities of these highly innovative investment vehicles."

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