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The chief US financial regulator is flexing its muscles again, both at home and abroad.
The Securities and Exchange Commission has set a deadline of Wednesday for many US and foreign hedge fund managers to register with it. They must provide the regulator with information about their businesses and brace themselves for the possibility of inspections.
The extension of the SEC’s supervisory work to hedge funds, where wealthy investors put their money, represents a big expansion of its powers and responsibilities. However, intense controversy and uncertainty surrounds the regulator’s flagship project.
A federal appeals court was asked in December to strike down the SEC’s rule requiring hedge fund managers who advise more than 14 investors to register with the regulator.
Phillip Goldstein, a New York-based hedge fund manager, says he is “cautiously optimistic” that the court will support his argument that the SEC did not have the authority to draw up the rule in October 2004.
William Donaldson, the SEC’s Republican chairman at the time, had to rely on the support of the regulator’s two Democratic commissioners to get the rule approved. He insisted the rule was necessary for the SEC to gain a full understanding of the traditionally secretive hedge fund industry, which controls assets worth $1,200bn.
More than 1,000 hedge fund managers had registered with the SEC before the rule was approved. Some did so voluntarily, while others had to if they were advisers to mutual funds, for example.
But the SEC estimated that a further 1,000 hedge fund managers would have to register following the rule.
Mr Donaldson said the growth of hedge funds had been accompanied by increasing instances of fraud. He highlighted 51 SEC investigations into hedge fund managers accused of fraud between 1999 and 2004. Since then the SEC has brought a further 30 cases, including against Samuel Israel III, founder of the Bayou group of hedge funds, where investors had put $450m.
Today, concerns about the SEC’s registration rule focus on compliance costs, and the risk they will be passed on to investors in the guise of reduced returns. Hedge fund managers, for example, must appoint chief compliance officers at their businesses. But Ernst & Young, the accountants, last month published a survey of 109 managers that found 85 per cent thought the annual costs to be $500,000 or less, which was “generally below market projections”.
Some hedge fund managers appear to be taking steps to avoid having to register with the SEC by Wednesday. Managers do not have to register if after February 1 they do not take additional money from existing clients or accept contributions from new investors. They also do not have register if they bar clients from withdrawing their investments for more than two years.
SEC officials say the UK and Hong Kong are the most significant overseas jurisdictions for hedge fund managers. By the end of last Thursday, 113 hedge fund managers based outside the US were registered with the SEC. Of these, 68 are in the UK and seven are in Hong Kong.
In London, some hedge fund managers regard the SEC’s oversight as unwarranted, given that the Financial Services Authority, the chief UK financial regulator, scrutinises their industry. “Outside the US, the feeling is that the FSA is completely on top of hedge funds, far more than anyone else in the world,” says Philippe Bonnefoy, partner at Cedar Partners, a London-based fund that invests in hedge funds.
In Hong Kong, hedge fund managers say they expect the bigger players to register with the SEC, partly because it would help them improve their image.
“They may not like it but they have little choice if they want to continue to attract US investors and not raise suspicions in the eyes of regulators,” says the Hong Kong-based manager of a large hedge fund.