SEC Probes Money Managers for Conflicts in Choosing Hedge Funds

The U.S. Securities and Exchange Commission, stepping up its oversight of investment advisers, is examining whether asset managers that channel money to hedge funds are acting in investors’ best interest.

The agency asked money managers for information about their “due diligence” in selecting alternative investments such as hedge funds, private equity and venture-capital funds, according to a letter from the SEC’s Office of Compliance Inspections and Examinations obtained by Bloomberg News.

The SEC, which created a specialized group last year to police asset managers, is refining industry oversight as more hedge funds come under its watch. The regulator also asked how money managers market their funds and whether they signed confidentiality agreements with those they invest in, according to the letter. Clients can’t easily verify performance and fees if the manager doesn’t disclose how the money is invested.

“This is further evidence of the SEC’s more proactive approach to the hedge-fund industry,” said Jay Gould, a former SEC attorney who’s now at Pillsbury Winthrop Shaw and Pittman LLP in San Francisco. “Hedge-fund managers, including funds of funds, can expect the agency to take a greater interest in their policies, practices and their relationships with investors and other fund managers.”

John Heine, an SEC spokesman, declined to comment.

IA Watch, a trade publication for investment advisers, reported the examination on Aug. 23. The Wall Street Journal reported on it today.

Trailed Recovery

Investors use funds of funds to spread money across a variety of holdings, relying on managers to investigate the individual funds. Funds of hedge funds trailed the recovery in the broader market last year, as some were hurt by investments in Bernard Madoff’s Ponzi scheme, according to data from Chicago-based Hedge Fund Research Inc.

The SEC asked for any written questionnaire used in seeking investments and explanations for why any specific investment was rejected, according to the letter. The exam also looks at client relationships, use of third parties in selecting investments, and use of so-called side-letter agreements.

Side letters are agreements that some hedge-fund advisers use to give certain investors privileges that other clients don’t receive. The SEC focused on potential problems with side letters as early as 2006, when it said some agreements may create conflicts of interest if they give investors priority status in selling holdings or more access to portfolio information.

To contact the reporters on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net; Joshua Gallu in Washington at jgallu@bloomberg.net.

To contact the editor responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net.

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