Regulation on the Horizon, Funds Automate Compliance
February 16, 2009
With hedge fund regulation viewed by many as a near certainty, fund managers are turning to an array of technology offerings and consulting services to cope with the anticipated rules.
Charles Grassley, R-Iowa, and Carl Levin, D-Mich., introduced a bill in the Senate late last month that would require hedge fund advisers with more than $50 million in assets under management to register with the Securities and Exchange Commission. An earlier bid by the SEC to impose a registration mandate was overruled by the U.S. Court of Appeals for the District of Columbia Circuit in 2006. The commission, in a very different environment, chose not to appeal.
Under the Hedge Fund Transparency Act, fund managers would not be subject to all of the rules and regulations that apply to mutual funds but would need to file an annual disclosure form, making detailed information publicly available. They would also have to maintain books and records for the SEC and cooperate with information requests and examinations.
But beyond having a chief compliance officer (CCO) in place, or assigning the functions to a COO or CFO, setting up and documenting compliance processes could be the most burdensome-and costly-task. Written policies will be needed for the archiving and monitoring of communications, know-your-customer programs and keeping tabs on investors and employees.
"The SEC and investors want to see a solid compliance infrastructure," says William Mulligan, CEO of HedgeOp Compliance, a New York-based consultancy and supplier of compliance software. For many, Bernard Madoff's alleged $50 billion Ponzi scheme has reenforced negative perceptions about how hedge funds are operated.
Celent estimates that hedge funds' compliance spending will reach $78.8 million in 2011, up from $41.5 million last year. "The numbers are likely to be even higher as more firms look to automate their compliance operations to keep up with a potentially expanding set of rules," says Celent analyst Isabel Schauerte. "A customizable rules engine can allow hedge funds to adapt to an evolving regulatory environment. Hedge funds may favor modular solutions that can easily integrate into larger financial operations systems, such as order management systems, to develop real-time compliance alerts."
Compliance Workflow
HedgeOp announced Jan. 27 that it had received a U.S. patent for ComplianceTrak, a workflow tool that outlines the steps fund managers should follow to ensure their compliance programs pass muster. The software, which Mulligan calls "technology-agnostic," has over 30 clients with a total of $35 billion in assets and can be customized for operational structures including single-manager funds and funds of hedge funds, both U.S. and offshore.
HedgeOp says ComplianceTrak alerts fund officials when investor eligibility guidelines are violated, when certain compliance thresholds are hit, or employees do not adhere to personal trading requirements. Generally, only qualified or accredited investors can put money in hedge funds--depending on its legal structure, a fund may have to include the underlying investors in a fund of funds. Managers monitor the holdings of pension funds to ensure they do not exceed 25 percent of the fund's assets, a level that forces registration with the Department of Labor as a plan fiduciary. Some hedges funds don't let employees trade the same securities as the fund, while others require staffers to check with a compliance officer before trading for a personal account.
