Federal regulators have completed work on controversial regulations meant to bring more oversight to the world of hedge funds.[@@]

The U.S. Securities and Exchange Commission has published the new regulations and discussions supporting and opposing the new regulations today in the Federal Register.

The final regulations, adopted under the federal Investment Advisers Act of 1940, are scheduled to take effect Jan. 10, 2005. The regulations will require affected advisors to respond to amended items in Form ADV in their next ADV filing after March 8, 2005.

The final regulations also will require affected advisors to register with the SEC by Feb. 1, 2006.

The SEC believes the new registration and reporting requirements apply to 975 hedge fund advisors.

The SEC is expanding the number of advisors who must register by changing the way advisors count their fund clients.

In the past, federal securities laws have required advisors to register with the SEC only when the advisors have had 15 or more clients. Many advisors have tried to get around the red tape facing ordinary retail mutual funds by aiming their services mainly at very small groups of wealthy, sophisticated individual investors.

Some advisors have created pyramid-like structures of trusts, limited partnerships or other types of private funds. Each trust may hold the assets of many individuals, but the advisor gets around the “15 client” limit by treating each trust as a single advisee.

Now, in many cases, the SEC will require advisors to “look through” the “top tier” investors and count the actual number of individual investors.

Advisors are not “required to ‘look through’ most clients that are business organizations, including insurance companies, broker-dealers and banks, but [they] are required to look through many types of pooled investment vehicles investing in securities, including hedge funds,” SEC officials write.

The SEC received 161 public comments on a proposed version of the regulations that it published in July, and officials note that opponents to the proposed regulations published editorials denouncing the draft in The New York Times, The Washington Post and The Wall Street Journal.

Many opponents of hedge fund advisor regulation believe that regulation will decrease the hedge funds’ efficiency and hurt the investment markets, the SEC officials write.

Cynthia Glassman and Paul Atkins, 2 SEC commissioners, have dissented from the full commission’s decision to approve the final regulations. Glassman and Atkins say sophisticated investors do not need the kind of regulatory help that ordinary investors need.

But, originally, “the private advisor exemption was not intended to exempt advisors to wealthy or sophisticated clients,” SEC officials who support the final regulations write in their discussion of the regulations.

Instead, the officials write, Congress exempted very small advisory operations because it saw no federal interest in regulating very small advisory operations.

In recent years, hedge funds and their advisors have come under increasing scrutiny because of rapid growth, unexpectedly heavy losses at some funds and concerns about fraud.

SEC officials who support the final regulations argue that even determining the size of the U.S. hedge fund industry is difficult because neither the SEC nor other agencies has been able to collect hedge fund data.

Private sources suggest that 7,000 U.S. hedge funds manage about $870 billion in assets, dominate the convertible bond market and account for about 5% of the daily trading volume of the New York Stock Exchange, the officials write.

The officials who support the final regulations note that many hedge fund advisors already register with the SEC and that those advisors’ funds seem to do about as well as the funds advised by unregistered advisors.

The SEC has posted the final version of the regulation at http://a257.g.akamaitech.net/7/257/2422/06jun20041800/edocket.access.gpo.gov/2004/pdf/04-26879.pdf