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Hedge fund overhaul coming

Date: Thursday, August 25, 2005
Author: Wojtek Dabrowski- Financial Post

OSC: Action plan to tackle regulations on fees, referrals, suitability requirements
Wojtek Dabrowski
Financial Post

Following the high-profile downfall of two hedge-fund firms, the Ontario Securities Commission is set to toughen up regulations that govern Canada's multi-billion-dollar hedge-fund industry and how the products are sold to investors.

The move is the result of a sweeping OSC review of the sector, which has been less closely regulated than other parts of the country's securities industry. Charlie Macfarlane, the commission's executive director, said the OSC hopes to have an internal action plan ready this fall.

"I think it's a matter of dealing with beefing up some areas of regulation to make sure that certain provisions aren't being misused and to make sure that certain provisions are as broad as they might be," Mr. Macfarlane said in an interview, adding: "I'm sure you will see regulatory action coming out of this."

Officials from the OSC's investment-funds, capital markets, enforcement and corporate-finance branches are involved in the task force's effort, which is being headed by Paul Moore, a vice-chair at the commission.

Under examination is everything from exemption rules for hedge fund products and suitability requirements to how clients -- particularly small retail investors -- are referred to hedge fund firms and how such products are sold by investment advisors.

Hedge fund transparency is also under scrutiny.

"We think we should better understand whether the transparency around hedge funds -- and in particular the fees charged in hedge funds -- is appropriate and adequate, particularly since small retail investors ... have become very much involved," Mr. Macfarlane said. "Also we'd like to better understand what custodial risks might exist with hedge funds."

Hedge funds in Canada have received much negative publicity since the February implosion of Portus Alternative Asset Management Inc., a Toronto-based firm with more than $730-million of assets under management.

Then, in May, regulators began investigating Norshield Financial Group, the Montreal-based hedge fund firm. Later, Norshield was ordered to stop doing business with clients.

In the past, hedge funds were the domain of wealthy, sophisticated investors with tolerance for risk. But the collapse of Portus, which had 26,000 investors -- many of them small -- illustrated how popular hedge fund products have become to retail clients.

A heavier regulatory burden could mean increased costs for the hedge funds. Canada's hedge fund industry is estimated to have as much as $20-billion in assets, though precise and current figures are difficult to obtain.

Mr. Macfarlane said the OSC task force will internally present an action plan this fall and plans to tackle the issue of referrals quite quickly.

"We've got no reason to believe that the hedge fund industry in general isn't very healthy," Mr. Macfarlane said. The OSC generally wants "to make sure that certain provisions aren't being misused and are as broad as they might be."

Also, the OSC is looking at exempt-product rules, Mr. Macfarlane said, to determine "whether or not that list of criteria from which you build the case that a product is exempt is robust enough," he said.

Portus sold "funds of hedge funds" linked to a purported principal-protected note -- a product that is exempt from certain regulatory requirements in Ontario and was sold to investors through an offering memorandum rather than a prospectus.

"Our concerns are more of the Portus nature than more of something else," Mr. Macfarlane said.

Davee Gunn, executive vice-president at Abria Alternative Investments Inc., said educating investment-advisors and investors about hedge funds is more important than increasing regulations of the product.

"It's not the form of the offering," Ms. Gunn said. "It's how you do due diligence and understand the risks."

She pointed to the tech meltdown in 2000, noting that many companies that left investors penniless sold their stock through prospectuses -- the more-regulated cousin of the offering memorandum.

However, she said the hedge funds industry would benefit from having the contents of offering memorandums standardized by regulators to make fund-to-fund comparisons easier. Also, an education course for advisors would be beneficial, she said.

Toreigh Stuart, the chief executive of BluMont Capital Corp., a hedge fund firm, said increased regulation of the sector "would be wonderful.

"I think it should be an even playing field, and for us, it would be a great thing."