Fraud made easier: New rules backfire

Date: Wednesday, January 19, 2011
Author: Kaja Whitehouse, New York Post

In a strange twist, new rules aimed at cleaning up Wall Street may make it easier for some investment managers to commit fraud.

When the Dodd-Frank financial overhaul act was passed last summer, its supporters promised greater scrutiny of big money managers, such as hedge funds and private-equity firms, that have long been allowed to fly under regulators' radar.

Starting in July, huge firms such as SAC Capital and Tudor Investment Management will have to start reporting key information such as assets under management and staffing levels.

What's less known is that federal regulators will also start shifting oversight of hundreds and potentially thousands of smaller money managers -- or those with less than $150 million in assets -- to officials in cash-strapped states.

The move has legal experts warning of a proliferation of funny business among money managers who handle a lot of mom-and-pop investors.

"The states currently have almost no examination staffs other than maybe a few like California and Texas," said Tom Westle, a partner in the New York office of Blank Rome.

"They are going to have to build these staffs, which means until they do there will be little chance to discover fraud by smaller advisers."

At issue are rules that raise the threshold for registration of money managers from $25 million to between $100 million and $150 million, depending on the type of manager.

Investment advisers, who may manage mutual funds or hedge funds, must now have at least $100 million to register with the Securities and Exchange Commission.

This change alone will push some 4,100 registered investment advisers from the SEC's purview on to the states, according to SEC head Mary Schapiro.

Jay Gould, a lawyer with Pillsbury's investment funds practice who drew attention to the issue on his firm's Web site, warns that the impression of lax oversight could stifle fund-raising by smaller managers.

"A lot of funds will say, 'Oh, I don't have to be registered with the SEC,' and think it's not so bad until they go out and try to raise capital," Gould said.

Of course, SEC supervision is no seal of approval, as Bernard Madoff's Ponzi scheme proved. Madoff's $65 billion investment arm was registered with the SEC as an investment adviser.

Under Schapiro, the SEC has taken steps to increase oversight of the space, including requiring random audits of certain money managers.

But as Michael Weinstein of law firm Cole Schotz notes: "If the SEC didn't catch someone like Madoff, can you image a small state with one-tenth the resources trying to catch someone like him?" kwhitehouse@nypost.com