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January 19, 2004 at 07:00 PM
This is the fifth article in an ongoing series that examines what’s ahead in 2004 from the viewpoints of industry experts.
NEW YORK (HedgeWorld.com)–Massive growth in hedge fund assets and a rash of fraud cases were the main reasons cited by the U.S. Securities and Exchange Commission for its initiative last year to study the industry. Observers expect both growth and regulatory pressure to continue in 2004, with firms becoming better organized and more widely accepted as a result.
“From what we’re seeing in the marketplace, there will be much broader distribution of hedge funds,” said John Kelly of Man Group, Chicago.*
Compulsory registration for most managers is one likely outcome of the regulatory probe. As many as 50% of managers already may be registered with the SEC and would therefore not be affected by any such requirement. And those not registered are subject to other regulations.
These include, as listed in a letter the Managed Funds Association sent to the SEC, fraud and insider trader prohibitions under U.S. securities laws; NASD and Commodity Futures Trading Commission rules for the large number of funds that are registered with these bodies; and anti-money laundering provisions in accordance with the USA PATRIOT Act once these are finalized.
Investors nevertheless are concerned about practices such as inflating asset values, but SEC registration might not provide protection against such misdeeds. In fact, many fraud charges involve registered investment advisers, as the MFA points out in opposing compulsory registration. In the case of Lipper and Co., for example, being registered did not prevent mispricing of convertible arbitrage assets. Manager Edward Strafaci was charged with fraud in this connection.
It would be wrong for investors to assume that because a firm is registered, regulators are keeping a close eye on it for investor protection, Mr. Kelly said. “I don’t think you can rely on regulators to do due diligence,” he said. Fund of funds managers, consultants and investors have to check for themselves.
Organization
However, registering would push firms to become better organized, as regulators want to see systems and processes. “When the SEC comes in to audit, they do a very detailed review of your record-keeping procedures,” explained Man Investments Inc. compliance officer Keith Kendrick.
“You have to document compliance processes and policies,” he added. “They look at how you maintain your books and records, what kind of documentation you have on file to show certain checks and balances are being executed.”
Another trend that boosts mainstreaming is the spread of information about hedge funds. U.S. broker-dealers and advisers are learning the benefits and risks of this type of investing and hopefully relaying the knowledge to their customers.
