SEC commissioner acknowledges backtrack on hedge fund investor eligibility

Date: Friday, November 23, 2007
Author: HedgeWeek

SEC Commissioner Paul Atkins acknowledged to delegates at the Edhec Alternative Investments conference in London that critical feedback from investors on proposals to tighten US eligibility criteria for investment in hedge funds has forced the regulator to rethink its plans.

In December 2006 the Securities and Exchange Commission drew up plans to create a new category of accredited hedge fund investor who would be required to have at least USD2.5m in investments, replacing a requirement dating back to 1982 that they should have a minimum wealth of USD1m.

The SEC proposed the increase in the minimum wealth requirement after its regulation requiring registration of hedge fund managers with US investors was struck down by the courts as exceeding its powers.

It was originally put forward as part of a package together with new regulations reaffirming the SEC's standing to pursue fraud and misrepresentation on the part of managers, replacing provisions that appeared to have been called into question by the judgement.

However, the hedge fund fraud regulation was implemented separately in August this year, and Atkins says the SEC is rethinking its approach to investor protection after receiving critical comments from individuals who feared they would no longer be able to invest in hedge funds to diversify their portfolios and reduce volatility.

In particular, he said, the regulator had been swayed by arguments that regulators should work toward creating uniformity of eligibility standards rather than each setting out their own measures. 'The present situation is truly complicated and only serves lawyers,' he said.

'In the latest round of comments we have received on the eligibility proposals we have been urged to address consistency issues. It has been pointed out that other types of investment could be even riskier than hedge funds.'

The SEC has also been told it should be wary of micro-management that might lead to unintended results. 'We share these concerns about unintended consequences,' he said. 'We are also aware that hedge fund managers are not targeting retail investors.'

He added: 'We must also be careful not to mislead investors into thinking that the SEC can protect them from every mistake by a hedge fund advisor or from losses, or that they don't need to carry out their own due diligence.'

Hector Sants, chief executive of the SEC's UK counterpart, the Financial Services Authority, told delegates at the Edhec conference while hedge funds were not responsible for the US sub-prime crisis and the resulting credit crunch, it had exposed weaknesses in some of their investment models.

'The crisis of confidence has made it clear that stress-testing by hedge fund managers must model the implausible,' he said. 'Many quantitative investment strategies are modelled on a limited history of back-dating.

Noting that funds could reduce problems during extreme market conditions through 'transparent, sensible lock-up arrangements', Sants also warned: 'Even some of the most experienced hedge fund managers have proven to be over-dependent on credit rating agencies' in assessing the risk of complex structured credit products.