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Lifting the Lid: Hedge funds stay under SEC's radar

Date: Friday, June 15, 2007
Author: Karey Wutkowski, Reuters

WASHINGTON (Reuters) - Hedge funds are flouting one of the few U.S. disclosure regulations applying to them. But instead of punishing them, the U.S. Securities and Exchange Commission may scrap one of the rules to make it more palatable for the funds, according to SEC officials.

This would be another blow to some lawmakers and regulators who have been seeking, yet largely failing, to bring the secretive industry out of the shadows.

The $1.5 trillion hedge fund industry is playing an increasingly powerful role in financial markets, whether it is funds calling for the ouster of poorly performing CEOs or financing private equity takeovers.

Attorneys working with hedge funds acknowledge that funds often do not file the so-called Form D private placement document that tells regulators and the public when they start a new fund and also discloses some other details, including who owns 10 percent or more.

Although the document is modest in scope and filed in paper form, making it difficult to view, some hedge funds rankle at having to disclose any information. They also know the SEC lacks enough staff to check that every fund submits the form when starting a new round of capital-raising.

Indeed, the American Bar Association sent a letter to the SEC in March acknowledging the problem.

"Since many private offerings are conducted in compliance with all the requirements of Regulation D but for the filing of Form D, that requirement does not serve even a data-collection purpose," the ABA letter said.

Keith Higgins, who helped draft the letter and is a partner in Boston with the corporate law firm Ropes & Gray, said members of the committee who put together the memo told him it is "definitely the case" that hedge funds fail to file Form Ds. "They like to operate in a bit of a veil of secrecy or as much secrecy as possible." he said.

Now, the SEC is considering changes, which could include ending the requirement to disclose who owns 10 percent or more and introducing electronic filing, SEC officials said.

The agency already said publicly at an open meeting last month that it is hoping to make the form electronic.

David Cushing, a partner at Crow & Associates which advises hedge funds, said the industry has grown so much in the last decade that any public information is coveted.

"The environment has become very competitive, and people may use the information to the detriment of the fund through alternative trading strategies," Cushing said.

But some experts question whether easing existing regulation is the correct way to get hedge funds to comply. "As a policy matter, it's wrong to change rules to entice people to follow the law," said Mercer Bullard, a securities law professor at the University of Mississippi.

Regulators tried to get a better handle on the industry by requiring them to register with the SEC and submit to random inspections. But an appeals court last year overturned the rule, saying the SEC lacked authority to regulate hedge funds.

The industry's lack of transparency is a concern to House Financial Services Committee Chairman Barney Frank, who has called for global leaders to study the funds' effects on markets.

"Private equity and hedge funds have, in a short period, become owners and movers of vast pools of financial capital, with significant influence on the real economy, employment and long-term competitiveness for our companies," the Massachusetts Democrat wrote in a letter to President George W. Bush last month.


Hedge funds and other investment vehicles that are exempt from registration or periodic reporting requirements are nonetheless required to file a Form D with the SEC within 15 days of their first sale of securities in a fund.

The form's original purpose was to notify regulators that a fund was going into business, not to detail operations.

"It gave the SEC a basis for having some information," said Barry Barbash, a former SEC director of investment management who now advises hedge fund clients for Willkie Farr & Gallagher. "For example, if the SEC, in the course of doing a routine review, came across information that the fund was engaging in insider trading, the SEC would have some background."

Form D requires a fund to disclose being how much it intends to raise, how much it has already raised, the names of its managers and the 10-percent beneficial owners in the fund.

Barbash said it can be in a hedge fund's best interest because it can smooth the way for them to do private capital raising. The SEC's acceptance of a Form D theoretically tells a fund that it is exempt from more disclosure requirements.

The changes the SEC is considering -- dropping the beneficial owner disclosure and requiring electronic filings -- would make it easier for hedge funds to comply. Still, it will mean that regulators and others who want to know more about who owns the funds are likely to get even less information.