The writing is on the wall. With the Dodd-Frank Wall Street Reform and Consumer Protection Act now law, as of July 11, 2011, state regulators will be in charge of overseeing and auditing investment advisors (including advisors to hedge funds) with $100 million or less in assets under management (AUM). There is an exception for hedge fund and private equity advisors with less than $150 million under management utilizing the private advisor exemption.
Prior to this legislation, states have generally only regulated firms with $25 million or less in AUM and the Securities Exchange Commission (SEC) has generally been responsible for overseeing firms with AUM of $25 million and above. According to Pertrac’s 2009 Hedge Fund Database study, there are roughly 3,000 additional single-strategy hedge fund managers and roughly 1,500 additional fund-of-hedge fund managers that will come under state regulation next year with the implementation of the new Act.
Will States Be Up to the Task?
Clearly the number of investment firms in the $25-$100 million AUM bucket makes this a daunting task for state regulators. Now that the SEC will be eyeing the big fish and systemic risk, state agencies are busying adjusting to meet their new mandate. Still, questions revolve around each state’s capacity, capability, and process. For example, in a dismal budget environment, will agencies be successful in their attempt to win more resources to handle the workload? Additionally, will the states be able to hire the right kind of new regulators who truly understand alternative investment structures, risk management procedures, and operational technicalities of hedge funds?
Don’t Assume “Registered” Equals “Safe”
To their credit, the states are evaluating options and instituting new policies to address resource constraints and consistency in process. However, as the states take on more oversight it is reasonable to expect challenges in coverage and depth of examination out of the gate. One of the unintended consequences of this change in “oversight” may be that the investing public, and some financial advisors, will become complacent and assume that “registered” equals “safe.”