Hedge funds are a step ahead of the first mandatory registration rule from the U.S. Securities and Exchange Commission as the typically secretive industry has opened its books to regulators since the 2008 financial crisis.
What could have been a difficult adjustment to an unprecedented disclosure system, set to take effect March 30, will come to an industry already accustomed to some SEC oversight as hedge funds and private-equity firms have stepped forward to register with regulators.
“It’s just a big yawn, because they’ve already complied, and it changes nothing in their daily operation,” said Perrie Weiner, international co-chairman of securities litigation at law firm DLA Piper LLP in Los Angeles, who advises some of the largest hedge funds. “Although it’s not a great development for the hedge-fund industry, it’s tolerable.”
Some of the largest hedge-fund firms already are SEC-registered, including Paulson & Co. Inc., Renaissance Technologies LLC, Bridgewater Associates LP and AQR Capital Management LLC. The industry leapt into SEC supervision as major investors, spooked by the financial crisis, looked for regulated venues for their money.
“The markets began to evolve, and there needed to be a certain sense of credibility,” Weiner said. “Their investor bases demanded it.”
In the past three years, institutional clients have become the majority among hedge-fund investors, making up 61 percent of fund assets, according to London-based research firm Preqin Ltd.
Among the top 5 percent of SEC-registered managers, the average number of funds per firm is 79, the agency said in documents discussing the rule. Those who have resisted SEC registration until now will generally be smaller firms because they haven’t been able to run more than 14 funds in order to use the exemption, according to the SEC.
The future disclosures will “aid investors and prospective investors in conducting due diligence and could further help investors and other industry participants protect against fraud,” the SEC said in its final rule.
“I’m not sure that there’s going to be any kind of significant impact,” Peter Rup, chief investment officer at New York-based Artemis Wealth Advisors LLC, whose client portfolios include 40 hedge funds. He said the industry’s third-party administrators are more useful than regulatory disclosures.
In 2004, the SEC unilaterally tried to demand hedge-fund registration, adopting a rule that was struck down by a court ruling in 2006 that the agency had overstepped its authority. In 2009, Senators Chuck Grassley, an Iowa Republican, and Carl Levin, a Michigan Democrat, introduced a bill that was echoed a year later in the Dodd-Frank Act.
“Instead of the free flow of reliable information that markets need to function properly, today we have confusion and uncertainty fueling an economic crisis,” Grassley said in a January 2009 statement.
“Your average investor in a hedge fund doesn’t care, never did care; all they care about is the rate of return,” Weiner said. This action is less about investors than about “regulators looking to restore their reputation and to remain the ultimate watchdogs in the capital markets,” he said.
The rule, approved June 22 in a 3-2 decision by the commission, calls for hedge funds and private-equity firms managing more than $150 million in assets to report information about their investors and employees, the assets they manage, potential conflicts of interest and their activities outside of fund advising.
“It would provide much more detail about each fund that an adviser manages,” said Jamie Nash, a law partner at New York-based Kleinberg Kaplan Wolff & Cohen P.C., who represents hedge funds. “I don’t think managers are afraid of registration. I just think there are going to be a lot of costs associated with it.”
Nash said whatever costs the firms face will erode investor returns.
The Managed Funds Association, a Washington-based lobbying group, supports the new registrations and is “optimistic” the SEC action “will provide greater clarity and sufficient time for our members as they work to fully comply,” Richard Baker, the group’s chief executive officer, said in a statement.
“I think it’s a physical impossibility that the SEC audits every fund every year,” Rup said, adding that he hasn’t been impressed with what he’s seen of agency inspections. “They request reams of data. They look at very little. They tend to be very unsophisticated.”
SEC Chairman Mary Schapiro has said that the agency doesn’t have enough staff to adequately inspect investment advisors. A staff study in January showed fewer than one in 10 advisers were inspected in 2010.
Even if the inspectors are overbooked, “managers need to operate their business as if they’re going to be examined at any time,” Nash said.
With a registration and disclosure system now in place, the hedge-fund industry also wonders how to interpret a little-debated provision of Dodd-Frank that allows advisers registered with the Commodity Futures Trading Commission to avoid SEC registration.
Some major fund firms are already registered as commodity-trading advisers with the CFTC and not with the SEC, including SAC Capital Advisors LP, Soros Fund Management LLC, Tudor Investment Corp. and Lone Pine Capital LLC. Those that focus on securities will have to shift to SEC registration, Weiner said.
Two Republicans sent Schapiro an April 5 letter seeking to clarify how fund advisers might stick with CFTC registration. The letter from Alabama’s Spencer Bachus, chairman of the Financial Services Committee, and Oklahoma’s Frank Lucas, chairman of the Agriculture Committee, asked the SEC to provide advice on how those now under the CFTC could be exempt from the SEC rule.
Schapiro responded in a letter on June 1, saying that the Dodd-Frank exemption for CFTC-registered advisers is “self-executing.” The SEC won’t offer further guidance unless a firm requests specific help “based on the particular facts” it faces, she wrote.
When asked whether the agency would act against advisers that interpret the law as allowing them to choose CFTC registration, John Nester, an SEC spokesman, said that the agency’s staff “hasn’t taken a position on the provision, but as a general matter we can and do take steps to uphold congressional intent.”