SEC Ponders Different Approach for Hedge Funds
July 25, 2006
The Securities and Exchange Commission is considering its regulatory options in response to a June court decision that struck down the agency's hedge fund registration rule, SEC chairman Christopher Cox told the Senate Banking Committee.
In testimony Tuesday in which he referred to "addressing the hole" created by the U.S. Court of Appeals for the District of Columbia Circuit, Cox gave no indication that he plans to appeal the ruling in a case brought by Phillip Goldstein, a portfolio manager from Pleasantville, N.Y. who is a principal in a group of three hedge funds called Bulldog Investors. Instead, Cox will recommend that the agency promulgate a new antifraud rule that would clarify the fiduciary duties that advisers owe to their investors.
Cox also wants the agency's staff to address the growing concerns about the "retailization" of the hedge fund industry, or its accessibility to individual investors below high-net-worth status. The rule that the court invalidated included a provision that would have changed the net worth in the definition of "accredited investor" to $1.5 million from $1 million, including the value of a home. Cox told the committee that the court decision left regulators with a definition that was outdated and "wholly inadequate to protect unsophisticated investors from the complex risks of investment in most hedge funds."
Cox also discussed a possible rulemaking that would make SEC registration less burdensome for offshore funds with U.S. investors.
Beyond these proposals, Cox said he will direct the SEC staff to continue its examinations of hedge fund advisers who remain registered. He said current estimates are that at least half of the 2,500 advisers registered with the SEC will voluntarily remain registered.
"The concerns about hedge funds that the SEC enunciated when we adopted our hedge fund rule in December 2004 remain the same today," he said. "Notwithstanding the Goldstein decision, hedge funds today remain subject to SEC regulations and enforcement under the antifraud, civil liability, and other provisions of the federal securities laws."
"It doesn't sound like the SEC is going to appeal," said Lindi Beaudreault, a former SEC enforcement official who is now a partner in the Washington, D.C. office of law firm Alston & Bird. In her view, the most significant issues raised by Cox relate to the need for further rulemaking to protect retail investors. "I think most advisers [already] believe they have fiduciary duties to their investors," she said.
On the legislative front, there is a bipartisan effort underway to tackle hedge fund regulation. Rep. Richard Baker, R-La., and Rep. Barney Frank, D-Mass., are working on a revamp of a 1999 bill that put the Federal Reserve in charge of monitoring the industry.
"Regulation is sorely needed," said Darren Sherman, a former official in the SEC's division of investment management and office of compliance inspections and examinations who is now CEO of New York-based consulting firm Regulatory Advisory Services. "SEC enforcement cases against hedge fund advisers are on the rise," said Sherman. "This is a clear indication that rigorous oversight is needed to protect the interest of the public."
Cox noted that the number of enforcement cases against hedge funds has grown from four in 2001 to a cumulative total of ninety since then. "As you consider the possibility of legislation, the SEC stands ready to assist you, should you request it," Cox told the committee.
