Divided SEC Votes to Subject Hedge Funds to Oversight

Date: Saturday, January 8, 2005

U.S. Securities and Exchange Commission Chairman William Donaldson won his fight to extend SEC oversight to hedge funds, passing regulations opposed by the $866 billion industry and his two fellow Republican commissioners. The rule, adopted by a 3-2 vote, requires hedge fund managers to register with the agency and gives SEC inspectors power to review the books of the closely held investment partnerships. Today's order will give regulators a better understanding of an industry that has grown more than 20-fold since 1990, Donaldson said. ``How could an agency that is responsible for investor protection not have any authority or oversight over an industry that grown to almost $1 trillion,'' Donaldson said after the meeting in Washington. ``I believe this initiative is extremely important.'' The rule change spurred a yearlong lobbying campaign and pitted Donaldson against critics such as Federal Reserve Chairman Alan Greenspan and Treasury Secretary John Snow. Some of the biggest hedge funds, such as Caxton Associates and Lone Pine Capital, along with more than 1,000 others probably will sign up with the SEC because of the order. Democratic SEC Commissioners Roel Campos and Harvey Goldschmid joined Donaldson in backing the rule today, as they did in June with their support of new governance rules for mutual funds. Republican Commissioners Paul Atkins and Cynthia Glassman cast dissenting votes. ``I am befuddled as to why we are charging ahead in the face of such a groundswell of principled opposition to this action,'' Atkins said. ``The commission would do better to keep its eye trained on the mutual funds and broker-dealers to whom average Americans trust so much of their money.'' Sophisticated Investors The hedge fund industry, through its Washington lobbying arm, said it was disappointed. ``It remains our opinion, and one that is obviously widely held, that the case for the SEC's proposal was not made,'' John Gaine, president of the Managed Funds Association, said in a statement. Gaine said that the group, which has 800 hedge fund members, will work with the SEC as it sets up the new regulatory regime. Because they are meant for sophisticated investors, those with a net worth of at least $1 million, hedge funds have been exempt from SEC oversight. The funds can bet on securities that rise or fall and often use leverage to boost their returns. SEC staff said the agency needed to boost hedge fund regulation because more small investors are investing in the partnerships, mainly through pension plans. Agency officials also cited increased fraud in hedge funds and said they played a major role in the recent mutual fund trading scandal. Investment Advisers The new SEC rule, which won't take effect until 2006, requires managers that run hedge funds with at least 15 U.S. clients and $30 million in assets to register as an investment adviser with the SEC. Advisers must give the agency such information as their names, addresses and how much money they manage. Registration also lets the SEC conduct periodic inspections of the investment advisers. Under the rule, hedge funds would be required to name a chief compliance officer and develop safeguards to uncover fraud. SEC officials have estimated that about 40 percent of hedge fund managers already register with the agency. Most of those funds chose to come under the agency's oversight because they are hoping to attract pension funds and other institutional investors that require their investment funds to be registered. Steven Persky, a managing director at SEC-registered hedge fund Dalton Investments LLC, said registration is not burdensome. `Good for the Industry' ``Given the importance and size of hedge funds, and that the investment management industry is regulated, it makes sense to have a certain amount of oversight for hedge funds,'' said Persky, whose Los Angeles firm has $700 million under management. ``It's good for the industry because it encourages a level of transparency and record keeping.'' Hedge funds, with more than a year before the rule is effective, may sue the SEC to stop the regulation. Several hedge fund attorneys filed public comments last month with the agency arguing that only Congress has the legal authority to change the law governing investment advisers. Firm Ground Donaldson, speaking to reporters after the meeting, said he wasn't worried. ``I believe we are on very firm ground intellectually and legally,'' he said. Senate Banking Committee Chairman Richard Shelby, whose panel oversees the SEC, said in a statement that he was sensitive to some of the concerns raised by Greenspan and others that the new rule would impede the efficiency of the markets. ``I believe we must carefully balance investor protection concerns with potential disruptions to our financial markets,'' said Shelby, an Alabama Republican. ``The committee will continue to look at this rule to ensure that it is achieving its intended purpose.'' Hedge fund assets rose to $866 billion in this year's second quarter from $39 billion in 1990, according to Hedge Fund Research in Chicago.