Comply or Else

At face value, the new hedge fund requirements seem hardly onerous, especially if you’re part of the SEC formulating the rules and not a hedge fund manager attempting to comply with them. In a nutshell, all US funds with at least 15 investors and/or $25 million in assets under management are, under the Investment Advisers Act of 1940, required to register with the US watchdog. Most funds are treating these requirements as occupational burdens that come with the territory, although I’m willing to bet that if the US alternative asset management industry were asked whether registering with the SEC was necessary or likely to protect investors, the answer would be an unequivocal "no."

Having said that, there were an appreciable number of forward-thinking funds—more than 40 percent of US funds, according to SEC Chairman William Donaldson—already registered with the Commission prior to the move to make registration mandatory. I suspect many have welcomed this mandate in as much as it provides the industry with at least a semblance of credibility and transparency.

On closer inspection there’s more to the SEC measures than meets the eye. All qualifying funds are also required to appoint a chief compliance officer (CCO) who can "carry the can" for the fund should the SEC find evidence of "irregularities" during an audit. It’s unlikely that the US hedge fund industry would show signs of collective paranoia induced by the knowledge of an impending SEC visit, given the regulator’s well-publicized shortages in terms of headcount and financial resources. Naturally, Donaldson would scoff at those assertions, but you don’t have to be a quantitative analyst to work out that the SEC was blissfully unaware of the dodgy trading practices between certain hedge funds and their mutual fund counterparts before New York Attorney General Eliot Spitzer’s chance discovery at the expense of Canary Capital in September 2003.

There is a world of difference between the mutual fund scandal precipitated by illegal trading practices and the issue of hedge fund registration, and most industry buffs would agree that Spitzer is another proposition altogether. After his last exposé, Isure there are more than a few US financial institutions that would like to see the back of the Attorney General. Period.

Most industry practitioners that I have questioned about the SEC requirements scheduled to come into force at the beginning of next year believe that these measures are not a prelude to more prescriptive regulation. Call me a cynic, but I don’t buy that for a moment.

Granted, it is unlikely that the SEC will make any drastic changes to its requirements immediately following February 2006, but just wait until the first signs if a new scandal starts to surface. The SEC will be all over the industry like the proverbial cheap suit, complete with litigation, ensuing fines and, of course, more prescriptive compliance regulations. This type of stealth regulation has happened too many times in too many industries for this to be an unlikely scenario, and the only players positioned to benefit from the SEC’s increased attention are the technology vendors.

That includes the investors because I’m siding with SEC Commissioner Paul Atkins on this one. No matter how stringent the regulations governing the hedge fund industry are, you’re never going to get to the stage where you can mitigate every type of risk. It’s either a case of that or regulating the industry to such an extent that you effectively kill the goose that laid the golden egg. Take your pick.

Victor Anderson is editor of Hedge Funds & Investment Technology and can be reached via e-mail at

victor.anderson@incisivemedia.com.