Surprise inspections in store for U.S. hedge funds: SEC
WASHINGTON Hedge-fund and private-equity managers will have to open their books to surprise examinations by the Securities and Exchange Commission under a controversial proposal approved by the agency on Friday, about four years after a court struck down a similar SEC rule.
The proposal, which is based on the sweeping bank-reform Dodd-Frank Act, would also require fund managers to disclose details about their assets and investors.
“The enhanced information will better enable regulators and the investing public to assess the risk profile of an investment adviser and its funds,” SEC Chairman Mary Schapiro said.
The agency is required by DoddFrank to adopt the rules by July 2011, but Schapiro said she hopes to approve the rules well in advance of the deadline.
The SEC in late 2004 adopted a similar rule under the oversight of William Donaldson, who chaired the agency between 2003 and 2005. The rule required hedge funds to register with the agency and to open up their books to periodic examinations; a federal court subsequently struck it down in 2006.
Many hedge-fund and private-equity managers are not now required to register because they advise fewer than 15 private funds. But a large number of hedge-fund managers voluntarily register, in part to woo institutional investors with the security of federal oversight.
Critics argue, however, that the agency lacks the resources to conduct frequent periodic exams of fund managers and prevent fraud, even with new funding to hire additional examiners.
Robert Plaze, associate director of investment management at the SEC, told MarketWatch that his staff has grown substantially in the past year, but he hopes congressional appropriators provide significant additional funds in the years to come. He also pointed out that some fund managers that had registered after the agency approved its previous registration regulation chose to de-register after the court struck down the rule.
“They may have had reasons, but you always wonder why,” he said.
The new rule would require hedgefund managers with more than $100 million in assets to register with the agency. Fund managers with less than that would be subject to state authority. The proposal also exempts foreign fund managers that do not have a “place of business in the U.S.” from the registration rule.
Schapiro acknowledged that the SEC’s limited resources make it difficult to adequately examine fund managers, but she argued that the statute reduces the agency’s responsibilities by raising the asset threshold to $100 million, from $25 million before.
Sean O’Malley, a partner at White & Case LLP in New York, said that the SEC will need to more than double its current staff to adequately investigate all the new registered fund managers that will be coming on board by July 2011.
He added that even with the higher threshold for registration, the SEC could still have a very big task on its hands.
“There are clearly a lot of hedge funds and private-equity-fund managers with over $100 million in assets under management,” he said.
In part, the proposal is a response to money manager Bernard Madoff ’s $50 billion Ponzi scheme. Madoff didn’t hire an outside custodian, which helped him facilitate the fraud he committed before his fund collapsed last year. The proposal requires fund managers to identify their auditors, prime brokers, custodians and administers.
The Dodd-Frank Act exempts venture-capital funds from the registration requirement. In seeking to comply with the statute, and also make sure that some hedge funds and private-equity firms don’t pass themselves off as venture capitalists to escape oversight, the SEC introduced a proposal seeking to define what a venture-capital fund is.
According to the proposal, venturecapital funds are only defined as entities that invest in equity securities of private operating companies to provide primarily operating or business expansion capital. A venture-capital fund is not leveraged and the fund offers to provide managerial assistance to the underlying businesses.