SEC rules hit European FoHFs

LONDON – European hedge fund managers who have never sold to US clients may still be subject to registration with the Financial Services Authority (FSA) by February 2006.

Cynthia Fornelli, former deputy director of the investment management division of the Securities and Exchange Commission (SEC) says: "The rules, which came out at the beginning of December, treat the clients of fund of hedge funds (FoHFs) as the clients of the single-manager hedge fund. A manager must look through the FoHF to the underlying clients and view them as their own. Therefore, if a FoHF which invests with a European manager and has over 15 American investors the underlying hedge fund manager must register."

The SEC also requires registration of hedge fund managers with $25m (and or 15 clients) invested from US clients. This rule does not apply to non-US managers. For example, if a European hedge fund has 14 US investors and $26m from them, it does not have to register until it takes on that 15th client. The amount of money invested with the fund is irrelevant.

This registration leaves offshore funds vulnerable to audits of books and receipts. However, there is a loophole in existence: if the lock-up period for the FoHF’s investment is two years or more, then the FoHF itself is treated as the client. In this way a manager could avoid registration.

Fornelli and the SEC are expecting litigation over the rules. The hedge fund lobby in the US was successful and persuaded two SEC commissioners, Cynthia Glassman and Paul Atkins, to vote against the rules. Commissioner Campos was persuaded to give an extended time frame for compliance.