WASHINGTON (HedgeWorld.com)–Paul Roye, director of the division of investment management of the Securities and Exchange Commission, speaking to an audience of lawyers Thursday, dropped several hints about the direction of the SEC’s ongoing inquiry into the hedge fund industry.
There has been much speculation in recent weeks that the SEC is ready to draft a report by the end of the year recommending increased regulation for hedge funds, perhaps requiring hedge fund managers to register as investment advisers.
Mr. Roye’s remarks, the keynote address to the eighth annual advanced American Law Institute–American Bar Association Course of Study, Investment Management Regulation, were of course accompanied with the usual disclaimer that the views he expressed were his own and not those of the SEC or his colleagues on the staff thereof. Still, he cannot but have stoked the flames of speculation.
Mr. Roye said that the inquiry has focused especially upon “incidents of fraud with these funds, conflicts associated with managing these funds alongside mutual funds, and the increasing retailization of these funds.” He said nothing about the timing of a staff report to the commissioners, but he did promise that it would present them with a “comprehensive record.”
On a closely related matter, he discussed the custody rule at some length. This is the rule that mandates the separation and identification of client funds and securities left in the custody of an adviser under the Investment Advisers Act. He said that it has not been substantively revised since 1962. To dust it off for the new century and because “our examiners have on occasion discovered an adviser keeping certificates in an office file” where they might easily be lost or destroyed, the SEC has now proposed amendments requiring advisers with custody to maintain the funds and securities with a broker-dealer, bank or other qualified custodian.
The proposed amendments to the custody rule would effectively exempt from its requirements “advisers to limited partnerships and other pooled investment vehicles” because those vehicles have contractual means to protect themselves from the misuse of their assets. In much of his speech, Mr. Roye may have been building a case for a revision of those amendments that would abolish that exemption, subjecting hedge funds to the custody rule. He said that many comments have addressed the meaning of the term “qualified custodian” and other “issues of scope,” and that the staff was taking these comments very seriously as it moved toward a recommendation to the commissioners on the final rule.
On another closely related issue, Mr. Roye said that his division is looking closely at hedge funds of funds. These types of funds are suitable, he said, only for sophisticated investors. It is worrisome, he thought, that they have become available to a wider range of investor than has historically been the case, because smaller investors are pooled together to meet the higher minimum investments that the underlying hedge funds require.