Regulatory Focus on Hedge Funds Continues

The regulatory focus on hedge funds continued during the first quarter of 2012, as new iniatives continued to roll out, and milestones in the implementation of rules put on the books last year were hit.

For “large” hedge funds, we see the summer deadline for filing the Form PF looming large. Required by the Dodd-Frank Act, the Form PF asks for a vast amount of information on hedge fund positions, exposure and risk. While the information will only be available to the government for “risk oversight” purposes, large filers are not only preparing the form itself right now, they are analyzing how to respond to the inevitable requests from investors for the information they provided on the form.  While smaller hedge funds have a first filing date in early 2013, they will face similar questions from investors (but a smaller form requiring less information).

On another front, the implementation of the Large Trader ID rules have now come into effect. “Large Traders”, which include many hedge funds, have received their ID numbers from the SEC and have presumably distributed them to their broker-dealers. The broker-dealers are the ones doing most of the work in this regime. The B-D’s will maintain records, report to the SEC and possibly monitor certain Large Traders, all in the hopes of preventing another “flash crash” or other such calamaty or wrong-doing. Hedge funds have to keep their list of broker-dealers current with the SEC by filing quarterly updates — not too onerous a job, but this does require some attention.

During the first quarter, the CFTC jumped into the regulatory act by eliminating an exemption from registration under which many hedge funds operate. This action will result in these exempt fund advisers having to register with the CFTC by the end of the year (in addition to the SEC or state registration that they have already done earlier this year). Along with increased oversight by the CFTC, additional disclosures will be required to investors, and employees with significant trading and marketing roles will have to become registered and pass the Series 3 exam.  In April, a lawsuit challenging this new requirement was filed by the Investment Company Institute.  In response, Barney Frank stated “It’s just incredible to me….It’s just mindless yearning for the old ways.” The lawsuit’s outcome is uncertain at this time.

Perhaps the biggest development of the quarter was one that received the least press: the SEC entered into comprehensive arrangements with both the Cayman Islands Monetary Authority (CIMA) and the European Securities and Markets Authority (ESMA) as part of long-term strategy to improve the oversight of regulated entities, including hedge funds, that operate across national borders.  This follows on to similar “memoranda of understanding” (“MOU’s”) entered into with Quebec and Ontario. This brings the total number of MOU’s that the SEC has entered into to EIGHTY (80). These arrangements detail procedures and mechanisms by which the SEC and its counterparts can collect and share investigatory information where there are suspicions of a violation of either jurisdiction’s securities laws, and after a potential problem has arisen. As enforcement and supervisory tools, they are the key elements to success for a regulator, due to the global operational presence of most hedge funds.  This is particularly true as it relates to the SEC and CIMA, which provides a home to many of the world’s hedge funds.  CIMA’s chairman, Mr. George McCarthy, OBE, JP stated,  ”This MOU with the SEC is particularly important as Cayman is a major domicile for hedge funds and securities in which US institutions and persons of high net worth invest. It will enable more effective supervision on both sides.”

On the flip side of all these new regulatory developments, there was actually a lessening of regulation as the SEC loosened marketing restrictions on hedge funds in the JOBS Act, allowing for lighter restrictions on public statements and disclosure by hedge funds.  While the specific rules are yet to be released by the SEC, any move forward in this area is welcome.  (See my blog post on 5/26/11 entitled “Hedge Funds and Advertising:  “No Advertising Rules More Confusing Than Ever”.)

We will continue to advise of new developments in this area.