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Competitive Regulators Might Scapegoat Hedge Fund Industry

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NEW YORK (–Goaded by the aggressive investigations of New York State Attorney General Eliot Spitzer, the Securities and Exchange Commission could be looking to increase hedge fund regulation to show it is dealing with financial industry problems.

Recent scandals mainly concern mutual funds, but hedge funds might look like a convenient whipping boy for regulators who want to prove they’re taking action. The issues Mr. Spitzer uncovered on the mutual fund side have stimulated the SEC to play catch up, said Michael Tannenbaum of Tannenbaum Helpern Syracuse and Hirschtritt LLP, a law firm with a financial services practice.

Two agencies playing one-upmanship is potentially dangerous for the industry, he noted.

Judging from the SEC’s request for more money to hire additional staff, including auditors for the investment management division, the movement to require hedge fund managers to register as investment advisers is not going away, Mr. Tannenbaum said.

A senior adviser to SEC chairman Donaldson has stated that hedge funds willingly participated in mutual fund market-timing schemes. “We are poised in a situation where hedge funds stand to become scapegoats for all the ills of the financial industry,” said Mr. Tannenbaum.

Market Solution

Institutional investors increasingly are investing in hedge funds and are in a position to demand procedures and policies that protect investor interests, he said. He said that there is no need for additional regulation, which could discourage financial innovation and the formation of new hedge funds, thus ultimately working against investors.

But hedge funds have something of a public image problem, mostly related to their typically secretive mode of operation. That makes them the ideal fall guy. “A few high-profile hedge fund problems have created a negative perception of the industry as a whole,” said Thomas Walek, president of Walek & Associates, a public relations firm with hedge fund clients.

“Ironically, this negative view has in part been created by existing regulations,” Mr. Walek said. “Regulations on the books now inhibit hedge funds from talking about what they do and how they do it and can restrict them from differentiating themselves in a crowded marketplace.”

What is the solution? Mr. Tannenbaum recommends giving regulators plenty of feedback. It is important for the industry at large to comment on proposed laws and regulations, he said. Mr. Tannenbaum was recently named president of the Hedge Fund Association .

Mr. Walek for one is sanguine. He expects the current regulatory review to give fund managers the ability to provide greater disclosure and transparency, thus contributing to a healthy, growing market.

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